Accrued Liabilities Background
Accrued liabilities represent expenses that have been incurred but not yet billed. These expenses can be periodic and predictable, such as payroll expense or real estate taxes, or infrequent and unpredictable. The purpose of accrued liabilities relates to the matching principle of accrual-based accounting, which is the form of accounting prescribed by U.S. GAAP (Generally Accepted Accounting Principles). The matching principle indicates that expenses for products received or services provided should be allocated to the period reflective of the use of the product or service, rather than the date in which the service or product was paid.
A key factor in identifying accrued liabilities is noting that these balances are estimates made by the company for services provided or products received in a specific accounting period. The lack of an invoice provided to the company at the end of an accounting period forces the company to estimate the cost of their services or products received in the period. Services or products received in the period and coupled with an invoice are going to result in an exact cost and the liability would be considered an account payable.
Accounting Examples for Accrued Liabilities
Assume a company had a payroll period ending on December 30th, 2020, but not paid until January 5th, 2021. On January 5th, 2021, the company made a payment of $100,000 to payroll expense. The matching principle indicates that the company needs to accrue for the total value of the $100,000 in payroll expense on the December 2020 financial statements, as all of the payroll expense incurred relates to revenues and operations shown on the 2020 financial statements. The journal entry for this accrual is shown below.
December 31, 2020
On January 5th, 2021, when the company pays each of its employees, a journal entry can be made to eliminate the payroll accrual as follows:
January 5, 2021
The example above is highly predictable and can be performed with a simple calculation. Another example of an accrued liability would be related to medical claims, which are paid in the month incurred, or in the following month to two months following the date incurred. Since the company obviously cannot know what sort of December 2020 medical claims will be paid in the future periods, it is the responsibility of management to develop an estimate for medical claims to be paid in the future that relate to the prior period. This estimate is typically determined using historical data and benchmarking. U.S. GAAP recommends a company be conservative in their estimates in order to not mislead any individuals who may rely on their financial statements.
Why are Accrued Liabilities Important
Accrued liabilities are necessary for any company. Without accruing these liabilities, a company’s financial statements will overstate the profitability of their revenues.
Contact a GBQ representative if you are a small business or a rapidly growing company and have further questions about accrued liabilities or the associated estimation processes.
Article written by:
Chris Gerarde, CPA