Accrued Libilities

Accrued liabilities is a line item on a company’s balance sheet which represents liabilities that arise out of accrued expenses, which are expenses that are incurred but not yet paid.

Accrued expenses are normally periodic expenses which are paid in arrears i.e. after they are consumed. For example, a company’s electricity bill is received after the end of the month in which the electricity is consumed. It is important to record the electricity expense in the period in which the electricity is consumed by making relevant adjusting entry at the end of the accounting period. Accrual of expenses results in presentation of accrued expenses (in the relevant account heads like electricity expense, salaries expense, etc.) in income statement and accrued liabilities on balance sheet.

Accrued liabilities are recorded under the accrual basis of accounting in accordance with the matching concept. Generally accepted accounting principles require that expenses need to be recognized in the period in which they are incurred and not in the period in which related payment is made.

There is a subtle difference between accounts payable and accrued liabilities. While accounts payable are recorded in normal course of business based on proper invoices from suppliers, accrued liabilities are mostly recorded at the end of the accounting period and involves considerable estimation.

Accrued liabilities are normally reversed in the next period and the liability is recorded at the correct amount when relevant invoice is received.

Examples

Typical examples of accrued liabilities include:

Journal entries

ZK Construction, Inc. financial year ends on 30 June 2015. The board appointed its external auditor in May 2015 which started the audit in the last week of June. The initial estimation of total cost of the assignment was $15,000. After completion of the audit, the auditor sent an invoice for $17,500 representing the actual hours spent on the assignment.

Suggest accounting treatment for the following transaction.

The above example provides a good example of accrual basis of accounting and the process of recognition of accrued expenses and accrued liabilities.

The audit fee is recorded in the financial year ended 30 June 2015 because it is a regulatory requirement related to that year. It is recorded using an adjusting entry as at 30 June 2015 at an amount representing the best estimation of the eventual payment, which is $15,000.

Audit expense15,000
Accrued audit fee payable15,000

After closing entries are passed and financial statements for financial year 2015 are prepared, the company shall make a reversing entry cancelling the above accrual.

Accrued audit fee payable15,000
Audit expense15,000

In the next year when actual invoice is received, it is recorded and paid as follows:

Audit expense17,500
Audit fee payable17,500
Audit fee payable17,500
Bank17,500

The effect of accrual is that in the financial year 2015, audit fee of $15,000 appears in the income statement and accrued audit liability appear on balance sheet under current liabilities.

Written by Obaidullah Jan, ACA, CFA <--- Hire me on Upwork