Accrued expenses

What it means

Accrued expenses are an accrual item recording a cost that belongs to the current accounting period even though it will be paid only in a later one. In business accounting they are kept on account 383 and shown among liabilities in the balance sheet as an accrual, since they represent a future outflow of cash.

Typical examples are rent for the last quarter paid in arrears in January, December loan interest due in January, insurance for a period paid afterwards, or royalties invoiced after the year ends. The cost has arisen because the service or use has already taken place; only the payment comes later.

Accrued expenses mirror accrued income. They differ from prepaid expenses in direction: with prepaid expenses one pays in advance for the future, with accrued expenses one pays later for the past. If the amount is not precisely known, an estimated liability is used instead.

How it works in practice

At year-end we go through contracts with payments in arrears and check whether all costs for the year have been recorded. If a December cost has not yet been paid or invoiced but its amount is known, an accrued expense is booked against the relevant expense account. It is cleared when paid in the following year.

Recording accrued expenses correctly also affects tax. A cost becomes deductible in the year it belongs to if it meets the statutory conditions. For some expenses, however, such as late payment interest or certain bonuses, the law makes deductibility conditional on payment, which must be tracked separately.

For small, regularly recurring items, accruals are not made if this does not distort the result. The materiality principle decides. For larger items such as office rent or interest on a large loan, accruals are needed so that the year's result is complete.

What to watch out for

The most common mistake is forgetting costs paid in arrears, especially rent, energy or services with annual settlement. The result is then overstated and the cost appears the following year. At year-end it is worth going through invoices received in January and February to see whether they relate to the previous year.

Do not confuse them with estimated liabilities and provisions. Accrued expenses are used for a known amount and a certain obligation. An estimated amount calls for an estimated liability, an uncertain obligation for a provision. The wrong tool may not change the result but distorts the balance sheet, and the auditor will point it out.