Businesses face many different types of expenses, which aren’t always paid as soon as they’re incurred.
So, even if you have a healthy cash balance, this may not be a perfect representation of your financial positioning.
With some expenses, like utilities, you know you’ll owe the payment at some point in the future, even if you haven’t received the bill with the exact amount just yet.
This is referred to as an accrued liability, an important concept for companies using accrual-based accounting.
In this guide, we’ll define accrued liabilities, provide you with some common examples, and offer some helpful tips for accurately estimating and managing them.
What are accrued liabilities?
Accrued liabilities are expenses you’ve incurred during a certain period, but have not yet been billed for.
Put differently, if you’ve already received the benefit from an expense but haven’t received the invoice for it yet, it’s considered an accrued liability that you will owe at some point in the future.
The idea is that accounting for accrued liabilities provides an accurate representation of your current financial position, even if a cash transaction has not taken place.
Examples of accrued liabilities
Accrued liabilities are a normal occurrence in financial accounting, and are typically produced by regular business activities, though one-off events can cause them as well.
Here are some of the most common types of accrued liabilities:
Interest payments
When you borrow money, you will typically incur interest on the loan amount each day.
If you’re only making payments once a month, this is recorded as an accrued liability until the lender sends you a bill.
Payroll
Because you typically pay employees after they’ve provided labor over a given period, their wages are considered an accrued liability until you process payroll.
Taxes
You incur taxes as you generate revenue throughout the year.
However, you may only make annual or quarterly tax payments to the IRS.
Thus, the taxes you owe are recorded as an accrued liability until you’ve paid them at the end of the period.
Utilities
In general, you will receive a bill for utilities like gas, electricity, and water after you’ve utilized them during a certain period.
So, you may record utility expenses as an accrued liability until you’ve received the bill.
Other expenses
Any other expenses you’ve incurred, but haven’t been billed for, can be recorded as an accrued liability.
This might include services completed, like maintenance, or inventory you’ve received from a supplier. You’re still waiting on an invoice, but you know you will owe these expenses in the future.
How are accrued liabilities recognized and recorded?
Accrued liabilities are recognized under accrual-based accounting principles, not cash-based accounting. They are reported under current (or short-term) liabilities on the balance sheet.
The basis for recording accrued liabilities is the matching principle under Generally Accepted Accounting Principles (GAAP), which requires you to report expenses at the same time as the related revenues, even if that’s not when you pay them.
For example, let’s say you pay an annual bonus to employees based on 2% of the total revenues you earned in the fiscal year. This is paid out in January of the following year after performance figures are finalized.
So, if you generated $10 million in revenue in 2023, employee bonuses will total $200,000, paid out in January 2024.
But, based on the matching principle, you still need to report the bonus as an expense during the year in which they worked and generated revenue for the business, not when it’s paid.
Here’s what this will look like on your 2023 income statement and balance sheet.
Thus, the bonus payments are considered an accrued liability on the balance sheet until they have been paid in January, though the expense will be reported in the income statement as per the matching principle.
When bonuses are paid, your current liabilities will be debited and your cash balance will be credited by $200,000, with no impact on the income statement.
Accrued liabilities vs. accounts payable
Though they are both reported as current liabilities, there is a distinct difference between accrued liabilities and accounts payable that you should be aware of.
Accrued liabilities are expenses for which you’ve already received the benefit of, but haven’t been billed for.
These are often expenses you incur on a regular basis that don’t require a bill, like payroll. Or, it may represent bills you haven’t yet received from a provider, like utilities.
Accounts payable also represent expenses you need to pay. But, the key difference is that they are recognized and recorded when you receive an invoice for goods or services rendered, which typically need to be paid within a certain time frame.
For instance, when you receive an invoice from a vendor or supplier, you will update your accounts payable and begin processing the payment by the due date.
And, if you’re using an automated AP tool like BILL, you can have vendors send you digital copies of the invoices or snap a picture of paper copies to upload them into the system. From there, payments start processing automatically.
4 tips for estimating accrued liabilities accurately
Recording accrued liabilities helps you keep track of your financial obligations, even if you haven’t been billed yet.
However, it can be tricky to accurately estimate the amount of certain accrued liabilities before you receive an invoice.
Of course, certain accrued liabilities, like wages owed to salaried employees, are easier to estimate than usage-based expenses, like utilities.
Either way, accurate reporting of accrued liabilities is required to stay GAAP-compliant, so here are some tips and suggestions to help:
1. Review historical data
If you’re having trouble estimating a certain accrued liability, it can be helpful to review historical data or figures for similar expenses.
For instance, if you had a maintenance company come in and make some repairs on a piece of machinery, you may be unsure about the exact amount you’ll owe until they send you the invoice.
But, if you’ve gotten similar repairs done from the same company in the past, you can reference previous invoices to provide you with a better idea of how much you could be billed this time.
2. Consider seasonality
Make sure you account for seasonality when you are estimating accrued liabilities.
This is especially true for usage-based utilities like electricity or gas, which can vary throughout the year as the seasons change.
Using this example, if you live in an area with mild winters and hot summers, you may not pay as much for electricity in March as you do in July when you’re running the air conditioner full-time.
So, when finalizing your estimates, determine if there are any seasonal factors that could impact how much you will owe.
3. Use software
If you’re already using accounting software to manage your general ledger and other financial matters, there may be built-in tools to help you estimate accrued liabilities.
This feature will track past expenses and use data analytics and algorithms to estimate similar future costs.
4. Be conservative
When in doubt, it’s better to overestimate what you might owe rather than be surprised when you receive a bill that’s much higher than you expected.
Be thorough with your estimates, and if you’re unsure, favor a more conservative amount that will ensure you’re financially prepared.
Best practices for managing accrued liabilities
All businesses deal with accrued liabilities, so figuring out how to manage them properly can help you prepare accurate financial statements and meet GAAP requirements.
Though this can be a daunting task, here are some best practices to help you stay on top of managing your accrued expenses.
Be timely with accrued liability recognition
First, record accrued liabilities as you incur them to ensure you have an accurate view of your financial obligations.
Don’t wait for accrued liabilities to pile up before you record them, which could cause inaccuracies in your financial reporting, and provide you with a skewed view of your current positioning.
For example, if you’ve made a large order of goods from a vendor, promptly recording the appropriate journal entry will help you prepare for the large cash outflow and plan other spending accordingly.
If you wait to do so, you may think you have more cash available than you actually do and overextend yourself with excess spending. Plus, it may be a violation of GAAP standards for accrual-based accounting.
Make accurate estimates
As we discussed above, it’s important to make accurate estimates for your accrued liabilities, both for financial planning and compliance purposes.
Again, this helps you avoid surprises down the line when the bill arrives with the official amount owed.
Otherwise, you may face cash flow issues if the invoice shows you owe much more than you had estimated.
When you find an estimation process that works well for you, document it thoroughly to help guide you in the future.
Reconcile accounts frequently
Reconciling your accounts is the key to managing accrued liabilities and ensuring your expenses are properly recorded.
At period-end, compare your estimates for accrued liabilities against the actual cash payments you made to close out your books. Make the proper journal entry adjustments as needed for any expenses that ended up being less or more than you anticipated.
This step can help you identify discrepancies, make any necessary adjustments to account balances, and keep your financial records accurate and up to date.
The importance of accrued liabilities
Accurately tracking and recording accrued liabilities provides better transparency into your outstanding financial obligations.
Though making accurate estimates can be a challenge, businesses of all sizes need an established system for managing their accrued liabilities, which will help to optimize their overall accounts payable workflows.
