An accrued liability is an expense that a company has incurred during an accounting period but has not yet paid or recorded in its financial statements. Accrued liabilities are a part of accrual accounting, which records financial transactions when they are incurred, rather than when the cash is exchanged.
Accrued liabilities often arise when a company receives goods or services before it pays for them, or when it incurs expenses that will be paid in the future. These liabilities are recorded as accounts payable or other specific liability accounts, depending on the nature of the expense. Common examples of accrued liabilities include:
- Wages and salaries payable: Employee salaries and wages earned during an accounting period but not yet paid.
- Interest payable: Interest expense that has been incurred on a loan or other financial obligation but not yet paid.
- Taxes payable: Taxes owed to the government, such as income or sales taxes, that have been incurred but not yet paid.
- Utilities payable: Utility expenses, such as electricity, water, and gas, that have been used but not yet billed or paid.
To account for accrued liabilities, a company would record a journal entry at the end of the accounting period, debiting the relevant expense account and crediting the corresponding liability account. This ensures that expenses are recognized in the financial statements in the same accounting period in which they were incurred, adhering to the matching principle.
For example, if a company has $5,000 in wages earned by its employees during the last week of the accounting period but not yet paid, it would record the following journal entry:
Debit: Wage Expense – $5,000 Credit: Wages Payable – $5,000
By recording accrued liabilities, a company can ensure that its financial statements accurately reflect its financial performance and obligations during a given accounting period, providing a clearer picture of its financial health for management, investors, and other stakeholders.
Example of an Accrued Liability
Let’s consider a hypothetical example to illustrate the concept of accrued liabilities.
Imagine a company called “XYZ Services” that follows the accrual basis of accounting and has an accounting period that ends on December 31st. XYZ Services receives a monthly utility bill for its electricity usage, which covers the period from the 15th of the current month to the 14th of the following month. The company typically receives the bill around the 20th of the following month and pays it a few days later.
As of December 31st, XYZ Services has used electricity from December 15th to December 31st but has not yet received or paid the bill for that usage. To account for this accrued liability, XYZ Services needs to estimate the electricity expense for this 17-day period and record it in the financial statements for the current accounting period.
Let’s assume that based on historical usage and rates, XYZ Services estimates the electricity expense for the 17-day period to be $850. The company would record the following journal entry on December 31st:
Debit: Utility Expense – $850 Credit: Utilities Payable – $850
This journal entry recognizes the utility expense incurred during the accounting period and records the obligation to pay the accrued liability when the bill is received and paid in the following month.
By recording the accrued liability, XYZ Services ensures that its financial statements accurately reflect its financial performance and obligations for the accounting period, providing a clearer picture of its financial health for management, investors, and other stakeholders.