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The principle of accrued expenses is an important one in business accounting.
When you use an accruals balance sheet you’ll be able to produce more meaningful business data, and get a better handle on your company’s financial health.
|⚠️ Depending on the size and type of business you run, using accrual accounting may even be mandatory¹|
This guide covers a definition of accrued expenses, examples of accrued expenses and a run through of how journal entries can be used to reconcile accrued costs for your company.
|📝 Table of contents:|
Accrued costs - which are also simply called accruals - are those a business knows they’re liable to pay at a given date within the next 12 months, like rent, employee commission or loan repayments².
By using the accrued expense method of reporting, businesses can produce more accurate financial statements.
To give an example, perhaps you’ve entered into an agreement with a supplier to buy a certain quantity of products. However, you’re still waiting for the goods to be delivered, so you haven’t yet settled your bill, and you may not even have an accurate invoice available. The estimated cost of these goods would be captured as an accrued expense at the time it occurs - when you enter into the supplier agreement.
Accrued expenses are pretty much the opposite of prepaid expenses.
While accrued expenses represent commitments you’ve made to pay someone in future for goods or services, prepaid expenses work the other way around. With prepaid expenses you’ve already made payments towards goods or services which have not yet been delivered - a downpayment or deposit on a supplier invoice for example.
Accrued expenses are viewed as a liability, while prepaid expenses are seen as an asset.
|Accrued expenses example||Prepaid expenses example|
The accrual accounting method³ describes the process of costs being recorded in a company’s financial statements when they’re incurred - rather than when they’re paid. On the flipside of this, you can also have accrued revenues - which are payments which you’re expecting to receive but which have not yet been made to you.
The accrual accounting method is different to the cash accounting method, in which items are only entered into the company’s financial statement when cash changes hands.
The cash accounting approach risks misrepresenting a company’s financial position as it doesn’t cover known liabilities which will need to be paid in future, or known income which is due to be paid.
It’s therefore not a recommended method for larger businesses - and some business types in the UK are not allowed to follow this approach at all, like Limited Companies, for example¹.
It’s helpful to note that expenses - including accrued expenses - can be split down into operating and non-operating expenses.
Operating expenses are the costs of running a business day to day. They’re usually regular, predictable and ongoing - like the cost of paying employees or buying goods to sell.
Non-operating expenses on the other hand, tend to be irregular charges which don’t stem from the main running of the business. Common examples may be interest on a loan, or the costs of relocating to a new premises.
Operating costs are often split out from non-operating costs in order to give a clearer picture of the ongoing financial performance of a company. By removing one off and irregular charges, and anything not involved with the day to day activities of the company, it’s easier to see how healthy the financial performance on an ongoing basis is.
When you use accrual accounting you’ll need to reconcile accrued expenses with paid expenses to keep your books balanced over time.
You’ll want to take some professional advice to make sure you’re keeping your company accounts straight - but here’s the basic process as an overview:
|When you accrue the expense:|
By debiting the expense account you’re increasing the amount shown on your income statement as owed, and crediting the liability correspondingly increases your businesses liabilities on your balance sheet.
Once the payment has been made you need to reconcile the accounts.
|To balance everything up:|
Spend less time worrying about managing your company finances, and more on growing your business, with the Wise account.
Wise Business account offer linked debit cards for you and your team, so you can manage daily expenses more easily. Plus, multi-user access features mean you can set and manage user permissions so everyone has the financial tools they need to do their jobs - leaving you to concentrate on the things that make your business unique.
You’ll also be able to hold and exchange 50+ currencies, send payments to 80+ countries, and get paid like a local from 30+ countries. Connect with more customers around the world, pay international suppliers, and manage employee payroll across multiple currencies with simple batch payment options. All currency conversion uses the real mid-market exchange rate and low, transparent fees so you can save versus using your normal bank.
Check out the Wise business account today to boost your business and start saving both time and money.
- UK government - Who can use cash basis accounting?
- HMRC - Business Income Manual
- FRC - Financial Reporting Standards, UK and Republic of Ireland
This publication is provided for general information purposes only and is not intended to cover every aspect of the topics with which it deals. It is not intended to amount to advice on which you should rely. You must obtain professional or specialist advice before taking, or refraining from, any action on the basis of the content in this publication. The information in this publication does not constitute legal, tax or other professional advice from Wise Payments Limited or its affiliates. Prior results do not guarantee a similar outcome. We make no representations, warranties or guarantees, whether express or implied, that the content in the publication is accurate, complete or up to date.
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