An accrued expense is a cost the entity has incurred by the balance sheet date but has not yet recorded through the normal payables process, because no invoice has arrived or no payment has been made. Under accrual accounting, the expense belongs to the period in which the goods or services were received or the obligation arose, not the period in which the bill is paid. Accruals are among the most common year-end adjusting entries and one of the most common places for understated liabilities.
This guide covers what counts as an accrued expense, the journal entries for the usual items with worked arithmetic, reversing entries, how accruals differ from payables, and how auditors test them.
Accrued expenses vs accounts payable
| Accounts payable | Accrued expenses | |
|---|---|---|
| Source | Vendor invoice received and entered | Estimate or calculation by management |
| Documented by | Invoice, purchase order, receiving report | Contract, payroll register, schedule, calculation |
| Amount | Known | Often estimated |
| Entry | Bill entered in the payables module | Manual journal entry at period end (often reversed) |
The line between them is whether a bill exists. A utility invoice received in January for December usage is a payable if received before the books close and an accrual if not. Both are liabilities. Both belong in the balance sheet at year end. See accrued expenses and accrual basis accounting.
Common accrued expenses
- Wages and payroll taxes for days worked but not yet paid.
- Compensated absences (paid time off).
- Bonuses and commissions earned but unpaid.
- Interest on debt between payment dates.
- Utilities, rent escalations and other recurring services without an invoice at close.
- Professional fees: audit, legal and tax work performed but not billed.
- Property taxes and other taxes incurred but unpaid.
- Warranty and loss contingencies where the criteria are met. See ASC 450 loss contingencies.
Journal entries with worked examples
All figures are illustrative and the arithmetic is shown.
1. Accrued wages and payroll tax
A company pays biweekly. The pay period that ended Friday, December 26 was paid in full. The year ends Wednesday, December 31, so December 29, 30 and 31 are worked and unpaid. Biweekly gross pay is $120,000 over 10 workdays, or $12,000 per workday. Employer payroll tax is estimated at 7.65 percent (Social Security and Medicare only, for simplicity).
- Wages: 3 days x $12,000 = $36,000.
- Employer tax: $36,000 x 7.65% = $2,754.
| Account | Debit | Credit |
|---|---|---|
| Wages expense | 36,000 | |
| Payroll tax expense | 2,754 | |
| Accrued wages | 36,000 | |
| Accrued payroll taxes | 2,754 |
2. Accrued interest
The company has a $500,000 note at 6 percent, with annual interest paid on October 1. At December 31, three months of interest has accrued: $500,000 x 6% x 3/12 = $7,500.
| Account | Debit | Credit |
|---|---|---|
| Interest expense | 7,500 | |
| Accrued interest payable | 7,500 |
3. Accrued bonus
Employees earn an $80,000 annual bonus for the calendar year, paid in March. The obligation relates to service already rendered. Employer payroll tax at 7.65 percent is $80,000 x 7.65% = $6,120.
| Account | Debit | Credit |
|---|---|---|
| Bonus expense | 80,000 | |
| Payroll tax expense | 6,120 | |
| Accrued bonuses | 80,000 | |
| Accrued payroll taxes | 6,120 |
4. Compensated absences
ASC 710-10-25-1 requires accrual for compensated absences when four conditions are met: the obligation relates to rights attributable to employees' services already rendered; the rights vest or accumulate; payment is probable; and the amount can be reasonably estimated. If the employee has 80 unused hours carried forward and earns $30 per hour, the accrual is 80 x $30 = $2,400 for that employee, plus any payroll tax. Sum over employees, and review the policy for forfeiture and cap rules.
5. Accrued professional fees
The audit fee for the year is quoted at $24,000. By December 31, the firm has completed interim work representing about 25 percent of the engagement. An accrual of $24,000 x 25% = $6,000 is recorded, with the remainder expensed as the service is performed in the following year.
Reversing entries
Many accruals are reversed on the first day of the next period so the payment, when made, can be recorded without splitting it. For the interest example, a January 1 entry debits accrued interest payable $7,500 and credits interest expense $7,500. When the next interest payment is made, the full payment is debited to interest expense. The expense for the new year ends up correct because the reversal offsets the portion already booked in the prior year.
Reversal works well for accruals that will be paid in a single payment and are short-lived. It works poorly where the accrual is a balance that builds, such as compensated absences, where a rolling balance is updated through a new entry each period. Whichever method the client uses, apply it consistently, and make sure a reversal is not booked twice or skipped. A reversal that posts and then the invoice is also entered in payables creates a double count in expense.
In QuickBooks
In QuickBooks, accruals entered as bills dated at year end or as journal entries both reach the balance sheet. Journal entry lines that hit accounts payable need a vendor name, and a reversal must be entered or scheduled by the preparer, so list reversals in the close checklist. Check the accrued liabilities detail after close for reversals and for entries without support. See QuickBooks cleanup before the audit and auditing a client on QuickBooks Online.
How auditors test accrued expenses
The main assertions are completeness (all liabilities recorded), cutoff, and valuation. Understatement is the usual risk, since management has little incentive to record an accrual that lowers profit.
- Obtain the accrual schedule and agree it to the trial balance. The accrued expenses schedule template has the layout.
- Search for unrecorded liabilities. Examine disbursements and unpaid invoices after year end and trace them to the period of service. See search for unrecorded liabilities and subsequent disbursements testing.
- Test the largest and the recurring accruals against contracts, payroll registers and calculations. Recompute.
- Perform analytical procedures. Compare each category with prior year and with expectations, such as accrued payroll against payroll days outstanding. See analytical procedures.
- Evaluate estimates. Compare prior-year accruals to actual settlement amounts to see whether management's process is biased. See auditing accounting estimates.
- Confirm legal accruals through the legal letter process.
- Check classification between accrued liabilities, payables, and long-term items.
Common mistakes
- Booking an accrual with no support, so the amount cannot be tested later.
- Missing the payroll tax and benefits on top of wages and bonuses.
- Reversing an accrual twice, or leaving an old accrual in place after payment.
- Forgetting unbilled professional fees and utilities.
- Treating year-end invoices for January service as year-end expense.
- Omitting accrued vacation because the policy "has never been paid out".
FAQ
What is the difference between accrued expenses and accounts payable?
Accounts payable are supported by vendor invoices that have been recorded. Accrued expenses are estimates of obligations incurred but not yet invoiced or recorded. Both are current liabilities.
Do accrued expenses get reversed?
Often, yes. Reversing on the first day of the new period lets the payment be recorded in full without allocation. The method must be applied consistently.
Are accrued expenses current or long-term?
They are generally current liabilities, because they are expected to be settled within a year or the operating cycle. Long-term items, such as a non-current portion of a deferred compensation obligation, are classified separately.
How do I estimate an accrual when there is no invoice?
Use the contract terms, historical run rates, the payroll register or a supplier statement. Document the basis and compare it to the actual amount when the invoice arrives.
What do auditors look for in accrued expenses?
Unrecorded and understated liabilities, cutoff, and the reasonableness of estimates.
CORAA prepares ready-to-review audit files for US CPA firms from QuickBooks books; you review and sign. See /us.
Sources
- FASB ASC 710-10-25-1, Compensation, General, compensated absences (conditions for accrual); KPMG, Financial reporting presentation handbook (examples of accruals for compensated absences)
- AICPA, AU-C section 500, Audit Evidence; AU-C 540; AU-C 330; AU-C 501 (litigation, claims and assessments)
- IRS, Publication 15 (Circular E), for the Social Security and Medicare employer rates (6.2 percent and 1.45 percent), irs.gov
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AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error