What Is Accrued Liability? Definition, Types & Example
Understanding the financial position of your company is vital to maintaining a healthy cash flow. This is regardless of any transactions that have or haven’t been made.
In order to properly understand your finances, you need to have a firm grasp on the accrued liabilities of your business, but what exactly are accrued liabilities?
We’ll take a closer look at the definition, types, and give you an example of this accounting term. So that you can get a deeper understanding of your business.
Table of Contents
KEY TAKEAWAYS
- An accrued liability happens when a business estimates actual expenses that they have not yet paid out but that they have a commitment to pay.
- Expenses paid directly show up on the Income Statement. Unpaid expenses become an accrued liability on the balance sheet.
- Accrued liabilities are only used with the accrual method of accounting.
- Accrued liabilities can include wages, goods and services, and interest.
What Is Accrued Liability?
An accrued liability is a financial obligation. It happens when a business commits to an expense that they have not yet paid out. This tends to happen during the normal course of doing business.
Accrued liabilities will only exist in your business structure when you are using an accrual method of accounting. They require a debit to one of your expense accounts, and a credit to the accrued liability account. This is then reversed when you make a payment with a credit to the expense or cash account. As well as a debit to the accrued liability account.
With an accrual method of accounting in place, all of the business’s expenses are recorded in financial statements. These are recorded in the period of time in which they are incurred. However, this may differ from the period of time in which they are actually paid off.
Accounting For an Accrued Liability
To account for an accrued liability, you have to make a journal entry. When doing the accounts, you would mark a debit to the business’s expense accounts a credit to the accrued liability account.
When the next accounting period starts, this is then reversed. The payment is then made. The accrued liability account is debited and then credited to the expense account. This reverses the original transaction and balances the books.
What Are the Types of Accrued Liabilities?
There are two types of liabilities that a business using this method of accounting must account for. They are routine liabilities and non-routine liabilities. Let’s take a look at both types.
Routine Accrued Liabilities
A routine accrued liability is an expense that occurs regularly under the normal day-to-day operations of a company. They are also known as a recurring liability. Things such as loans, an accrued interest that is to be paid to a creditor for a financial obligation, are considered regular expenses. The business might be charged interest on it, but it won’t be paid for until the next accounting period.
Non-Routine Accrued Liabilities
The second type of accrued liability is a non-routine accrued liability. These are accrued expenses that don’t regularly occur. They are also known as infrequent accrued liabilities. These expenses aren’t a part of the business’s day-to-day operating activities. That means that they include unexpected expenses. These may be billed to the business, but they won’t have to be paid until the next accounting period.
Examples of Accrued Liabilities
A business can accrue liabilities for a number of varying reasons. This means that there are a large number of expenses that can be categorized as such. Here are some of the most common examples of accrued expenses.
Goods and Services
It’s very common for businesses to make an order and receive the goods or services before paying for them. At the end of an agreed-upon financial period, the business will receive a bill for what they have received.
Interest
If a company has a loan, then the interest paid upon it can be considered an accrued liability. This is because interest payments tend to be paid either monthly or annually.
Wages
It is common for businesses who pay their employees bi-weekly to have wages as an accrued liability. This is because a period of pay might extend into the following accounting month or year.
Summary
Having good knowledge and control of your business’s finances is vital. When using the accrual form of accounting, you should always make sure that you have accrued all expenses in the correct time period.
FAQs on Accrued Liabilities
Accrued liabilities are normally listed on a business’s balance sheet as current liabilities. These are then adjusted in the subsequent accounting period.
As you are owing money, accrued liabilities are counted as a form of business debt.
To close your accrued liabilities account, you first have to debit the account. This is then credited to the expense account. This reverses the original transaction and balances the books.
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