Accrued expenses are items that a company will recognize on its accounting ledger but has not paid cash for. This essentially represents a liability on the company’s ledger. For example, a company might incur utility charges, but the billing cycle for many utility companies means that the expense is not recorded on the company’s books. The accounting manager will therefore estimate the utility expense and accrue the expense amount.
Many companies accrue expenses in order to create an accurate picture of their net income. The income statement represents all sales revenue, cost of goods sold and expenses for a specific time period. Failing to include all expenses for the accounting period will result in higher net income reported for the accounting period. This can mislead investors or other stakeholders into thinking the company generated more income than it actually did. Business owners and managers can also have trouble reviewing this information from a historical viewpoint. Failing to report accrued expenses can result in the company’s management thinking that a certain time period is more profitable than other periods.
Many types of accrued expenses exist in the accounting realm. Wages, income or payroll taxes, interest payments, utilities and other operating expenses often fall under this category. While not necessarily a bad thing, accrued expenses can be a sign of poor accounting practices. Essentially, accruing items into the accounting ledger indicates that the company does not have sufficient information for recording transactions or it has delays in the accounting workflow. On the expense side, the accounts payable department is responsible for paying bills and recording expenditures. Companies that accrue too many expense items can indicate cash flow problems within the company.
Companies that record various accrued expenses may also wind up having to adjust their accounting ledger for any calculation errors. Many accrued expenses are estimates of expected expenses. Failing to use a proper formula or recording an incorrect amount can result in a dollar figure left in the accounting ledger. Because the accrual represents a liability, leftover amounts indicate the company still owes money to a vendor, supplier, government agency or employee. For example, if the accounting manager estimates $1,000 US Dollars (USD) in utilities expenses, but the bill is actually for $950 USD, there will be $50 USD left in the accrual account. Companies that fail to clean up the accounts will leave this in the accounting ledger and report this extra $50 as being owed by the company.