As a small business owner, you want to get a true picture of your company’s resources and financial responsibilities. This means you should recognize income as soon as you earn it and expenses as you incur them. If your company receives goods or services from suppliers and you pay for them in the following month or accounting period, and you recognize these accrued expenses before making the actual payments.
What Are Accrued Expenses?
Accrued expenses are the expenses your company incurs before you pay for them. Typically, you note these expenses as current liabilities, but you pay them in the next financial period. You need to log these expenses in your firm’s accounting books, such as on its balance sheet, because you must pay them in the future.
But why should you record accrued expenses before making the necessary payments? As a responsible business owner, you want your expenses to closely align with your revenues to increase accuracy in your firm’s financial statements. Without making the necessary journal entries, your profits may be too high and not reflect the actual income you make in a particular financial period. Besides, if you use accrual accounting for tax purposes, the government requires you to disclose these types of accrued expenses.
Examples of Accrued Expenses
Typical examples of expense accruals include salaries payable, utilities, and taxes you incur, for which the government has yet to issue an invoice. If you run a startup or small business, you might need to take out a loan to fund your day-to-day operations. You must to pay the loan and the accumulated interest at some future date. In this case, the interest serves as the accrued expense, and you recognize it during the current accounting period.
As another example of an accrued expense, imagine your company receives raw materials from a supplier near the end of the month, and you close your books before you receive an invoice from the supplier. In this case, you enter an accrued expense liability when you receive the raw materials and a materials expense when you actually pay.
Recognizing expenses even before you pay for them ensures your books stay up to date with your company’s current resources and financial obligations. With QuickBooks Online, you can organize your business finances and stay ready for tax time. Try it free for 30 days.