Companies can boast record sales and still face an ominous financial future. How? The looming weight of liabilities. In accounting, liabilities refer to a company’s financial obligations to employees, suppliers, lenders, governments, and shareholders.
Some liabilities need to be paid right away, like invoices from contractors or monthly interest payments to a bank. These are called current liabilities. Others—like future employee salaries, year-end bonuses, bills for forthcoming equipment, andtaxesowed—aren’t yet sitting on the books but will soon come due. These are called accrued liabilities and require a bit more foresight.
What are accrued liabilities?
Accrued liabilities are expenses a company owes but that have not yet been invoiced for payment. Also known as accrued expenses, these show up as current liabilities on a company’s balance sheet orprofit and loss report. The company counts accrued expenses against its net income until they’re paid off.
Accrued liabilities are a touchstone of accrual accounting. Favored by the largest and most complex businesses, accrual accounting does not only record transactions where money has changed hands. It also tracks accrued bills that haven’t yet been paid and accrued profits that clients will soon owe the company.
The opposite of accrual accounting is cash basis accounting. This simplified accounting method only records transactions when money changes hands. The cash basis method works for small companies with few employees or vendors. As businesses grow, they typically shift to accrual accounting, which lets them plan for future financial events.
2 Types of accrued liabilities
Businesses encounter two types of accrued liabilities in their corporate bookkeeping: routine accrued liabilities and non-routine accrued liabilities. Here’s how these differ:
- Routine accrued liabilities. A routine accrued liability regularly comes up through the course of business. Chief among these liabilities is accrued wages, like employee salaries owed months into the future. Companies must also account for accrued payroll taxes, which run hand-in-hand with employee salaries. Companies that borrow money from banks and investors must budget for routine accrued interest expenses, which they need to pay over the lifetime of a loan. They may also make regular payments on accrued services like marketing and accounting.
- Non-routine accrued liabilities. A non-routine accrued liability does not routinely appear in the company’s financial ledger. Examples include one-time payments to vendors for a specific product or service. For instance, a company might issue employee bonuses after an unexpectedly good year. If bonuses are not routinely given, they count as non-routine accrued liabilities.
How do accrued liabilities work?
An accrued liability does not come with a current balance due but requires payment in the future. Accountants include accrued liabilities as part of a formal financial statement, but may designate a special accrued liabilities account to cover this category of expense. The lifecycle of an accrued liability has two phases:
- Initial entry.When accountants note an accrued liability, they make a journal entry in a financial ledger. This entry describes the accrued expense and estimates its cost. It appears as a credit in the company’s accrued liabilities account and as a debit in its expense account.
- Resolution.Eventually, the company receives a bill for its accrued liability, which it pays. The accountant then debits the accrued liabilities account and credits the expense account. The end effect is a net-zero entry, thanks to the new expense recognition once the bill comes due.
For instance, an accountant may note a company has ordered new machinery for $6,500. The machinery vendor hasn’t sent a bill yet, but will when the machinery is delivered several months down the road. The accountant credits the $6,500 expense in an accrued liabilities account. Using accounting software, the accountant may flag the accrued liability and shift it to an active expense account when the bill comes due. When the company pays the bill, the accrued liability disappears.
Accounts payable vs. accrued liabilities
An accrued liability is not the same as a journal entry inaccounts payable. While both categories describe expenses that a company must pay in the future, there is a clear distinction between the two:
- Accounts payable.Accounts payable are expenses billed to the company. For an expense to qualify as accounts payable, it must come with an invoice for a balance due. The ledger item qualifies as accounts payable when a vendor submits a bill, or a monthly rent payment is due.
- Accrued liabilities.Accrued liabilities are known expenses that haven't yet been billed—those a company knows it must pay in the future. But the company doesn’t pay these bills in the current accounting period, either because a vendor hasn’t submitted an invoice or because the expense involves a service that hasn’t yet been performed.
Accrued liabilities FAQ
What are five examples of accrued liabilities?
Examples of accrued liabilities are future salaries (accrued wages), future interest payments (accrued interest), future taxes (accrued taxes), services to be performed in the future (accrued services), and future lease payments (accrued real estate costs).
Is accrued liabilities a current asset?
Accrued liabilities are not considered assets. These expenses are considered liabilities on a balance sheet
How do you record accrued liabilities?
Under the accrual accounting system, an accountant might record an accrued liability by making two journal entries. One is a credit to an accrued liabilities account; the other is a debit from an expense account. In the future, the bill comes due, and the company pays the invoiced cost. It then issues a credit to its expense account and debits its accrued liabilities account. The credit and debit amounts cancel each other out, for a net-zero entry, and the accrued liability disappears.
Where do accrued liabilities go on a balance sheet?
When companies commit to accrual accounting, they create an accrued liabilities account on their balance sheet, where they record accrued expenses as they come up. Over time, the company pays these expenses, records transactions, and removes pending expenses from the accrued liabilities account.