What Is Accrued Liability?
The term "accrued liability" refers to an expense incurred but not yet paid for by a business. These are costs for goods and services already delivered to a company for which it must pay in the future. A company can accrue liabilities for any number of obligations and are recorded on the company's balance sheet. They are normally listed on the balance sheet as current liabilities and are adjusted at the end of an accounting period.
- 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.
- These liabilities or expenses only exist when using an accrual method of accounting.
- Accounting for accrued liabilities requires a debit to an expense account and a credit to the accrued liability account, which is then reversed upon payment with a credit to the cash or expense account and a debit to the accrued liability account.
- Examples of accrued liabilities can include payroll and payroll taxes.
What Is Accrued Liability?
Understanding Accrued Liability
An accrued liability is a financial obligation that a company incurs during a given accounting period. Although the goods and services may already be delivered, the company has not yet paid for them in that period. They are also not recorded in the company's general ledger. Although the cash flow has yet to occur, the company must still pay for the benefit received.
Accrued liabilities, which are also called accrued expenses, only exist when using an accrual method of accounting. The concept of an accrued liability relates to timing and the matching principle. Under accrual accounting, all expenses are to be recorded in financial statements in the period in which they are incurred, which may differ from the period in which they are paid.
The expenses are recorded in the same period when related revenues are reported to provide financial statement users with accurate information regarding the costs required to generate revenue.
The cash basis or cash method is an alternative way to record expenses. But it doesn't accrue liabilities. Accrued liabilities are entered into the financial records during one period and are typically reversed in the next when paid. This allows for the actual expense to be recorded at the accurate dollar amount when payment is made in full.
Accrued liabilities only exist when using an accrual method of accounting.
Types of Accrued Liabilities
There are two types of accrued liabilities that companies must account for, including routine and recurring. We've listed some of the most important details about each below.
Routine Accrued Liabilities
This kind of accrued liability is also referred to as a recurring liability. As such, these expenses normally occur as part of a company's day-to-day operations. For instance, accrued interest payable to a creditor for a financial obligation, such as a loan, is considered a routine or recurring liability. The company may be charged interest but won't pay for it until the next accounting period.
Non-Routine Accrued Liabilities
Non-routine accrued liabilities are expenses that don't occur regularly. This is why they're also called infrequent accrued liabilities. They aren't part of a company's normal operating activities. A non-routine liability may, therefore, be an unexpected expense that a company may be billed for but won't have to pay until the next accounting period.
Journal Entry for an Accrued Liability
Accounting for an accrued liability requires a journal entry. An accountant usually marks a debit and a credit to their expense accounts and accrued liability accounts respectively.
This is then reversed when the next accounting period begins and the payment is made. The accounting department debits the accrued liability account and credits the expense account, which reverses out the original transaction.
When Do Accrued Liabilities Occur?
Accrued liabilities arise for a number of reasons or when events occur during the normal course of business. For instance:
- A company that purchases goods or services on a deferred payment plan accrues liabilities because the obligation to pay in the future exists.
- Employees may perform work for which they haven't received wages.
- Interest on loans may be accrued if interest fees were incurred since the previous loan payment.
- Taxes owed to governments may be accrued because they are not due until the next tax reporting period.
At the end of a calendar year, employee salaries 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 they aren't distributed until January, there is still one full week of expenses for December. The salaries, benefits, and taxes incurred from Dec. 25 to Dec. 31 are deemed accrued liabilities. These expenses are 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.
Payroll taxes, including Social Security, Medicare, and federal unemployment taxes are liabilities that can be accrued periodically in preparation for payment before the taxes are due.
Accrued Liability vs. Accounts Payable (AP)
Accrued liabilities and accounts payable (AP) are both types of liabilities that companies need to pay. But there is a difference between the two. Accrued liabilities are for expenses that have not yet been billed, either because they are a regular expense that doesn't require a bill (i.e., payroll) or because the company hasn't yet received a bill from the vendor (i.e., a utility bill).
As such, accounts payable (or payables) are generally short-term obligations and must be paid within a certain amount of time. Creditors send invoices or bills, which are documented by the receiving company's AP department. The department then issues the payment for the total amount by the due date. Paying off these expenses during the specified time helps companies avoid default.
Examples of Accrued Liability
As noted above, companies can accrue liabilities for many different reasons. As such, there are many different kinds of expenses that fall under this category. The following are some of the most common examples:
- Wage expenses: This is for work already performed by employees. The work is paid for in the next accounting period. This is common with employers who pay their employees bi-weekly, because a pay period may extend into the following accounting month or year.
- Goods and services: Some companies place orders and receive goods and services from their suppliers without paying for them immediately. As an accrued expense, the receiving company pays for these goods and services at a later date.
- Interest: A company may have an outstanding loan for which the interest isn't yet due. The lender may require this expense.