Expenses are a natural part of every business. Your business’s expenses must be properly tracked and recorded to achieve success and keep your business operational. Although all expenses are considered a liability, there are vital differences between accrued expenses and accounts payable.
Accrued Expenses
Accrued expenses are debts your company owes for services or goods that have yet to be paid. This type of outstanding debt is often due to a lack of invoice from the supplier but can also include payroll. These are considered current liabilities because the debt falls within a specific time frame, usually a year.
Accrued expenses can give your company a good reflection of your total financial health, which is why it’s essential to keep accurate records even though it can mean more work. Your accounting team will use estimates supported by reasonable and well-documented calculations to record your expenses before an invoice is received. Although these are estimates, you’ll have a better understanding of what your company owes once invoices come in, so you know how much money will be paid out.
What is “Accrued Liabilities” in Accounting?
Accrued expenses or accrued liabilities are much more common than people think. These expenses are recurring that can easily be estimated, such as payroll, but there are several other examples:
- Utility bills
- Subscription services
- Services or goods your company uses before receiving an invoice from a vendor
- Accrued interest or interest expenses that are owed but not yet recorded into your accounting ledgers
- Wages owed to employees that have yet to be paid
While the accrued expenses accounting is more accurate and can lead to better financial decisions, business owners typically prefer a cash basis accounting method due to the ease of tracking payments. However, it is recommended to choose the accrued expenses method for more reliable accounting methods.
Accounts Payable
Accounts payable, also referred to as payables or AP, are current liabilities set to be paid in the near future and are typically short-term debts. These debts have a time limit to avoid default and to maintain the financial health of your business.
Another way to look at an accounts payable expense is any goods or services you purchase on credit, such as your inventory. You buy merchandise from a vendor with the expectation that you’ll pay for your inventory later, typically 30 days from receiving the invoice, but 45, 60, or 90 day payment arraignments are also possible.
Examples of Accounts Payable
Anytime you make a one-time purchase, you record these debts as accounts payable. These expenditures do not include employee wages or loan repayment. Other examples include:
- Inventory or restocking merchandise
- Renovations to your office
- Office equipment such as cubicles, desks, chairs, etc.
- Hardware and software
Accrued Expenses vs. Accounts Payable
Accounts payable are recorded as soon as your company purchases credit. On the other hand, accrued expenses are registered as an estimate to be adjusted once the invoice arrives to formally balance your accounting books. While accrued expenses and accounts payable are considered liabilities, they have some key differences.
Accounts payable are short-term or one-off debts to be paid on credit. Anytime money will need to be paid but isn’t directly for a long-term expense would be considered an AP. A great example would be companies that receive commission payments for various departments. The accounting team would deposit the check into a payables account until such a time the money is paid out to the employees who earned the commission.
Accrued expenses are when you know you’re going to have a big bill that you’ll pay in the future generated over several periods, such as bonuses paid to employees. Bonuses are generally paid once per year, but because it’s for an entire year’s work, you’ll need to recognize 1/12 of the expense each month of the year and put the other side on the balance sheet as a liability that will need to be paid in the future.
Accrual vs. Invoice
Understanding the difference between accrual and an invoice is reasonably straightforward. Accruals, whether they are accrued expenses or accounts payable, are debts that will need to be paid, but no invoice has been received.
An invoice is a time-stamped document that itemizes the goods or services rendered, how much they cost, and when the bill will be due.
Key Takeaways
How you decide to run your business is 100% up to you. Whether you choose to take an accrued expenses approach or another approach, there is no one “correct” form of accounting that you should choose over another. However, some methods, such as accrued expenses and accounts payable, work better than others for small and medium-sized businesses.
It’s a good idea to understand the differences between accrued expenses and accounts payable, regardless of how you decide to handle your business to make the best financial decisions for your company.
