What is an Accrued Expense?
Accrued Expenses refer to a company’s incurred expenses related to employee wages or utilities yet to be paid off in cash — often due to the invoice not yet being received.
- What is the definition of an accrued expense?
- Are accrued expenses an asset or liability on the balance sheet?
- What are common examples of accrued expenses?
- What causes accrued expenses to accumulate in the first place?
Table of Contents
Accrued Expenses Definition
On the current liabilities section of the balance sheet, a line item that frequently appears is “Accrued Expenses,” also known as accrued liabilities.
An accrued expense is an expense that has been incurred — i.e. recognized on the income statement — but has not actually been paid yet.
Per the “matching principle” under accrual accounting, the benefit associated with the expense dictates when the expense appears on the books of the company.
Despite the fact that the cash outflow has not occurred, the expense is recorded in the reporting period incurred.
Similar to accounts payable, accrued expenses are future obligations for cash payments to soon be fulfilled; hence, both are categorized as liabilities.
Examples of Accrued Expenses
For example, let’s say that a company’s employees are paid bi-weekly and the starting date is near the end of the month in December.
The benefit of the employees working was received, so the expense is recognized in December, but the employees may not receive cash compensation until the following month, early January.
As a result, the accrued expense balance increases from the unpaid employee wages caused by the timing mismatch.
|Accrued Expenses Examples|
Accrued Expenses Accounting Process
Simply put, more accrued expenses are created when goods/services are received but the cash payment remains in the possession of the company.
Oftentimes, the reasoning for the delayed payment is unintentional but rather due to the bill (i.e. customer invoice) having not been processed and sent by the vendor yet.
Cash Flow Impact
The rules regarding the impact on free cash flow (FCF) is as follows:
- Increase → Positive Impact on Cash Flows
- Decrease → Negative Impact on Cash Flows
The intuition is that if accrued expenses increase, the company has more liquidity (i.e. cash on hand) since the cash payment has not yet been met.
By contrast, a decrease in accrued expenses means the company fulfilled the cash payment obligation, which causes the balance to decline.
Accrued Expenses Calculator – Excel Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Accrued Expenses Example Calculation
Typically, accrued expenses are closely aligned with operating expenses (e.g. rent, utilities).
With that said, the standard modeling convention for modeling accrued expenses is as a percentage of operating expenses (OpEx) — i.e. the growth in accrued expenses is tied to the growth in OpEx.
However, if the amount of accrued expenses is negligible, the account can be combined with accounts payable (A/P) or projected to grow in line with revenue growth.
Here, we’ll be projecting the expense as a % of operating expenses.
The following assumptions will be used in our model.
Year 0 Financials
- Operating Expenses (OpEx) = $80m — Increase by $20 Each Year
- Accrued Expenses = $12m — Decline by 0.5% as Percentage of OpEx Each Year
In Year 0, our historical period, we can calculate the driver as:
- Accrued Expenses % of OpEx (Year 0) = $12m / $80m = 15.0%
Then, for the forecast period, the accrued expenses will be equal to the % OpEx assumption multiplied by the matching period OpEx.
From Year 0 to Year 5, the accrued expenses % OpEx assumption declines from 15.0% to 12.5%, and the following change occurs in the projected values:
- Year 0 to Year 5: $12m → $23m
In closing, the accrued expenses roll-forward schedule captures the change in accrued expenses, and the ending balance flows into the current period balance sheet.