What it means
In business, you often receive goods or services before you receive the bill. Under accrual accounting, you must record this cost in the month you actually used the item, rather than waiting until the cash leaves your bank account.
This practice gives you an accurate, honest picture of your monthly profitability. For example, if your team works the final week of June, but you pay them in July, the salary cost belongs to June.
By creating an accrued expense at the end of June, you log that liability immediately. This prevents your June profits from looking artificially high and stops you from getting a nasty surprise later.
Without accrued expenses, your financial reports would swing wildly depending purely on when suppliers send bills. Managers rely on these entries to make smart budgeting decisions based on true operational activity rather than payment dates alone.
At the start of the next accounting period, when the actual invoice arrives and gets paid, you simply reverse or clear out the accrued expense entry to avoid double counting the cost. It is a vital bookkeeping rhythm that keeps your books clean and trustworthy.
An accrued expense is like eating a meal at a restaurant and recording the cost in your notebook immediately, even though the waiter has not brought the bill to your table yet.
In practice
Real-world examples
Example 1
Your digital marketing agency uses freelance designers in March worth $2,500, but the invoices only arrive and get paid in April. You record this as an accrued expense in March. March profit then reflects the design work that helped win March clients.
Example 2
Your boutique retail shop keeps the doors open through late November and December, incurring a $1,200 electricity bill that arrives in January. You accrue this cost in December. The shop's December profit is no longer overstated.
Example 3
A small software startup uses cloud hosting services in May costing $800, but the billing cycle rolls over to early June. The startup records an accrued expense for May. Its monthly gross margin therefore reflects the true cost of serving customers.
Think of it
An accrued expense is like eating a meal at a restaurant and recording the cost in your notebook immediately, even though the waiter has not brought the bill to your table yet.
Formula
Calculation
Total Accrued Expense = Value of Goods or Services Received but Not Yet Billed or Paid
Example. Your office uses cleaning services worth $400 in May. The invoice is not received until June.
1. Record the expense in May: Debit Office Cleaning $400, Credit Accrued Expenses (Liability) $400.
2. In June, when paid: Debit Accrued Expenses $400, Credit Cash $400.
Fuller month-end example. At 31 May a business identifies three unbilled costs: cleaning of $400, electricity used and estimated at $650, and contractor work of $1,950. The total accrued is $400 + $650 + $1,950 = $3,000, so it debits expenses $3,000 and credits accrued expenses $3,000. May's profit falls by $3,000, which is correct because the costs belong to May.
In June the invoices arrive: cleaning $400, electricity $680 and contractor $1,950, a total of $3,030. The accountant reverses the $3,000 accrual and records the real invoices of $3,030, so June's net expense is $3,030 - $3,000 = $30, which is just the estimate error on the electricity bill ($680 - $650).Case study
Seen in the real world
This is a fictional, illustrative scenario. Oakwood Cafe operates a busy coffee shop with a team of six baristas. At the end of November, the final week of staff wages amounts to $3,500. Because the standard fortnightly payroll cycle straddles the month end, this specific pay run will not actually be debited from the business bank account until the fifth of December. If the finance manager ignored this, November profits would look artificially high by $3,500 because the labour costs were omitted.
To fix this, the manager creates an accrued expense journal entry at midnight on November thirtieth, adding $3,500 to November wage expenses and creating a matching current liability on the balance sheet. When the payroll clears on December fifth, the accountant reverses the accrual entry and records the actual cash payment. This ensures November bears the true cost of generating its revenue, and December is not unfairly burdened with wages for work done the month prior. The business owners receive accurate monthly management accounts, allowing them to track labour efficiency properly.
Watch out
Common mistakes
- Waiting until an invoice arrives to record the cost, which distorts monthly profit figures.
- Forgetting to reverse the accrual entry when the actual bill is paid, leading to double counting of expenses.
- Accruing expenses for items or services that have not actually been received or used yet.
Questions
People also ask
What is the difference between an accrued expense and an accounts payable?
Accounts payable represents bills you have received from suppliers but not yet paid. Accrued expenses are costs you have incurred for which you have not even received a bill yet.
Do accrued expenses involve cash leaving the bank account?
No. An accrued expense is an accounting adjustment. Cash only leaves your bank account later when the invoice is formally processed and paid.
Why are accrued expenses important for small business managers?
They ensure your monthly profit and loss statements show the true cost of running your business, preventing you from overestimating your earnings.