What are Accrued Liabilities?
Definition: Accrued liabilities are expenses that a company incurs during a period but doesn’t pay in the same period. It can also be an obligation that a company has assumes in a period but has not received a corresponding invoice during the period.
Accrued liabilities are liabilities that reflect expenses that have not yet been paid or logged under accounts payable during an accounting period; in other words, a company’s obligation to pay for goods and services that have been provided for which invoices have not yet been received. Examples would include accrued wages payable, accrued sales tax payable, and accrued rent payable.
There are two general types of Accrued Liabilities:
- Routine and recurring
- Infrequent or non-routine
Routine and recurring Accrued Liabilities are types of transactions that occur as a normal, daily part of the business cycle. Infrequent or non-routine Accrued Liabilities are transactions that do not occur as a daily part of the business cycle, but do happen from time to time.
What Does Accrued Liabilities Mean?
An accrued liability is an expense that a firm has incurred but has not covered yet. This is a key element of the accrual method of accounting, which records expenses when they are owed and revenues when they are earned.
A company may have accrued short-term or long-term liabilities for a number of reasons, including purchased goods and services, tax liabilities, payroll obligations or interest expenses on a loan repayment. Companies report accrued liabilities under accounts payable.
An accrued liability is an obligation that an entity has assumed, usually in the absence of a confirming document, such as a supplier invoice. The most common usage of the concept is when a business has consumed goods or services provided by a supplier, but has not yet received an invoice from the supplier. When the invoice has not arrived by the end of an accounting period, the accounting staff records an accrued liability; this amount is usually based on quantity information in the receiving log and pricing information in the authorizing purchase order. The purpose of an accrued liability entry is to record an expense or obligation in the period when it was incurred.
The journal entry for an accrued liability is typically a debit to an expense account and a credit to an accrued liabilities account. At the beginning of the next accounting period, the entry is reversed. If the associated supplier invoice is received in the next accounting period, the invoice is entered in the accounting system. The effect of these transactions is:
- In the first period, the expense is recorded with a journal entry.
- In the second period, the journal entry is reversed and the supplier invoice is entered, for a net zero entry in the second period.
Thus, the net effect of these transactions is that expense recognition is shifted forward in time.
Most accrued liabilities are created as reversing accruals, so that the accounting software automatically cancels them in the following period. This happens when you are expecting supplier invoices to arrive in the next period.
Examples of accrued liabilities are:
- Accrued interest expense. A company has a loan outstanding, for which it owes interest that has not yet been billed by its lender at the end of an accounting period.
- Accrued payroll taxes. A business incurs a liability to pay several types of payroll taxes when it pays compensation to its employees.
- Accrued pension liability. A company incurs a liability to pay its employees at some point in the future for benefits earned under a pension plan.
- Accrued services. A supplier provides services to a company, but has not billed the company by the end of an accounting period, because it takes time to compile billings from the time sheets of its employees.
- Accrued wages. A company owes wages to its hourly employees at the end of an accounting period, for which it is not scheduled to pay them until the next period.
Accrued liabilities arise due to events that occur during the normal course of business. A company that purchased goods or services on a deferred payment plan will accrue liabilities because the obligation to pay in the future exists.
Employees may have performed work but have not yet received wages. Interest on loans may be accrued if interest fees have been incurred since the previous loan payment. Taxes owed to governments may be accrued because they may not be due until the next tax reporting period.
At the end of a calendar year, salary and benefits must be recorded in the appropriate year, regardless of when the pay period ends and when paychecks are distributed. For example, a two-week pay period may extend from December 25 to January 7.
Although the salaries and benefits will not be distributed until January, there is still one full week of expenses relating to December. Therefore, the salaries, benefits, and taxes incurred from December 25 to December 31 are accrued liabilities. In the financial records, expenses will be debited to reflect an increase in the expenses. Meanwhile, various liabilities will be credited to report the increase in obligations at the end of the year.
- An accrued liability occurs when a business has incurred an expense but has not yet paid it out.
- Accrued liabilities arise due to events that occur during the normal course of business.
- Accrued liabilities only exist when using an accrual method of accounting.