Accrued expenses at the end of one accounting period result in cash payments in a future period.

An accrual, or accrued expense, is a means of recording an expense that was incurred in one accounting period but not paid until a future accounting period. Accruals differ from standard Accounts Payable Transactions in that an invoice is usually not received and entered into Oracle before year end (June 30). Recording an accrual ensures that the transaction is recognized, per US GAAP, in the accounting period when it was incurred, rather than when it was paid.

For an expense to be recorded in the fiscal year, the expense should have been incurred, meaning that the goods should have been received or the services should have been rendered, by end of day June 30. As we navigate the analysis of invoices dated in July for prior service periods, we may need to reach out to you for help confirming the date that goods or services were received in relation to July unpaid invoices. Your guidance will help DFA accurately account for transactions in the proper fiscal year.

Please note that there is a tight turn-around time on these requests as we must reconcile the accruals, post to the Oracle system, and submit to UCOP by required systemwide due dates. All invoices that have a July date that cannot be confirmed by our department partners will be posted into the new fiscal year.

When recording an accrual, the debit of the journal entry is posted to an expense account, and the credit is posted to an accrued expense liability account, which appears on the balance sheet. When the University pays for the expense, an entry to reduce the accrued expense liability and to reduce cash is recorded by posting a debit to the accrued expense liability account and a credit to the cash account.

Examples of when an accrual is necessary:

• Scenario 1: A purchase order is placed on June 1 for lab equipment, and the equipment is received on June 28. An invoice for $3,000 is received on July 1 and is paid on July 30. An accrued expense of $3,000 must be recorded as of June 30 to ensure that the expense is properly accounted for in the current fiscal year. The way to accrue this expense is to record the receiving of the goods in Oracle.
• Scenario 2: An electric bill is received on July 15 in the amount of $6,000. The dates of electric service are from June 10 – July 10. An accrual would be necessary as of June 30 for $4,000, as two-thirds of the time of service occurred in June and one-third occurred in July.

Standard Accruals

Purchase Order Accruals

These accruals are recorded automatically by DFA based on receipts entered against purchase orders by the University departments. If goods are entered as received, but they have not been paid yet, the system will record the expense as an accrued expense. The expense associated with the invoice is booked when Accounts Payable enters the invoice, not when the invoice payment is sent to the supplier. Accruals will only be recorded for expenses greater than $500. Goods and services received by June 30 must be entered by 5 p.m. June 30.

Non-standard Accruals

Controller's Office Accruals

There are also other types of large accruals made during this process. Controller's Office accruals are recorded by the Controller’s office during the year-end financial statement process. These accruals are generally calculated by reviewing significant payments made after year end and determining if the related expenses occurred in the current fiscal year or the next fiscal year. For these accruals, departments and projects are not charged; rather these are charged to a special Controller’s office department. These accruals are generally determined after the general ledger is deemed final for financial statement reporting.

Reversal of Accruals

In the next fiscal year, the accruals for the prior fiscal year need to be reversed from the balance sheet so that expenses are not double counted when paid in the next fiscal year. Accruals are automatically reversed on the first day of the new fiscal year. Reversals of accruals are done automatically in Oracle when the option is selected to automatically reverse the entry in the next accounting period (doing so assigns the same journal class number to the reversing entry as the original entry).

If you want to keep your business running, you need to fork over some cash to buy goods and services. And sometimes, you might use credit to make these purchases, resulting in accrued liabilities.

Accounting lingo like “accrued liabilities” may sound complicated, but don’t panic. It’s actually pretty simple. Read on to learn the basics of accrued liabilities to keep your small business cash flow on track. 

Accrued liabilities, or accrued expenses, occur when you incur an expense that you haven’t been billed for (aka a debt). For example, you receive a good now and pay for it later (e.g., when you receive an invoice). Although you don’t pay immediately, you’re obligated to pay the accrued expense in the future. 

Generally, you accrue a liability in one period and pay the expense in the next period. That means you enter the liability in your books at the end of an accounting period. And in the next period, you reverse the accrued liabilities journal entry when you pay the debt. This shows the expense paid instead of a debt owed. 

You might also have an accrued expense if you incur a debt in a period but don’t receive an invoice until a later period. 

Keep in mind that you only deal with accrued liabilities if you use accrual accounting. Under the accrual method, you record expenses as you incur them, not when you exchange cash. On the other hand, you only record transactions when cash changes hands under the cash-basis method of accounting.

Accrual accounting is built on a timing and matching principle. When you incur an expense, you owe a debt, so the entry is a liability. When you pay the amount due, you reverse the original entry. Then, the entry is shown as an expense paid.

The accrual method gives you an accurate picture of your business’s financial health. But, it can be hard to see the amount of cash you have on hand. So as you accrue liabilities, remember that that is money you’ll need to pay at a later date.

Examples of accrued liabilities

You can gain accrued expenses in a number of ways. Here are some common examples of accrued liabilities:

• Accrued interest: You owe interest on an outstanding loan and haven’t been billed by the end of the accounting period.
• Accrued wages: Your employees earn wages but are paid in arrears, which is in the following period (e.g., pay period in October with pay date in November).
• Accrued payroll tax: You withheld employment taxes from employee wages but owe them next accounting period.
• Accrued goods and services: Although you receive a good or service, the vendor doesn’t bill you until a later date.
• Accrued utilities: You used utilities for your business but haven’t yet been billed. 

Recording accrued liabilities lets you anticipate expenses in advance. You recognize expenses earlier than you are billed. That way, you can accurately map out the money you owe.

How to record accrued expenses

Ready to record accrued liabilities in your books? If so, you need to create an accrued expense journal entry. 

Use debits and credits in your accrued expenses journal entry. This means you must make two opposite but equal entries for each transaction. So, how do you use debits and credits for your accrual accounting entries?

Accrued liabilities work with expense and liability accounts. A debit increases expense accounts, and a credit decreases expense accounts. Oppositely, a credit increases liability accounts, and a debit decreases liability accounts. 

Remember, accrued liabilities are reversing entries. They are temporary entries used to adjust your books between accounting periods. So, you make your initial journal entry for accrued expenses. Then, you flip the original record with another entry when you pay the amount due.

There are two steps to creating an accrued liabilities journal entry…

Step 1: You incur the expense 

You incur an expense at the end of the accounting period. You owe a debt but have not yet been billed. You need to make an accrued liability entry in your books.

Usually, an accrued expense journal entry is a debit to an Expense account. The debit entry increases your expenses.

You also apply a credit to an Accrued Liabilities account. The credit increases your liabilities.

What happens when you make these entries? Your expenses increase on the income statement. And, your liabilities increase on the balance sheet.

Step 2: You pay the expense

At the beginning of the next accounting period, you pay the expense. Reverse the original entry in your books.

Debit the Accrued Liability account to decrease your liabilities. When you pay a debt, you have fewer liabilities.

Credit an asset account. In this example, credit the Cash account because you paid the expense with cash. A credit decreases the amount of cash you have.

When you reverse the original entry to show that you paid the expense, you must also remove it from the balance sheet. This decreases your liabilities. And because you paid it, your income statement should show a decrease in cash. 

If you don’t adjust entries after paying expenses, you’ll have some issues in your books. Here are a few things that will likely happen:

• Liabilities will be understated on the balance sheet
• Expenses will be understated on the income statement
• Net income will be overstated

Bottom line: Your financial reports will make it look like you have more money than you do. Make sure you keep your entries up-to-date each time you pay a liability.

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Accrued expenses vs. accounts payable 

You might be thinking that accrued liabilities sound a whole lot like accounts payable. If you are, you’re right. Accrued expenses and accounts payable are similar, but not quite the same.

Both accrued expenses and accounts payable are current liabilities, which means they are short-term debts paid within a year. But, the difference between the two revolves around invoicing:

• Accrued expenses: Expenses incurred but not yet billed (i.e., you haven’t received an invoice yet). 
• Accounts payable: Expenses you’ve incurred and received an invoice for. You owe the supplier money. This also includes costs you bought on credit. 

This article has been updated from its original publication date of June 20, 2017. 

This is not intended as legal advice; for more information, please click here.

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