Definition: Accrued liabilities are expenses that a company incurs during a period but doesn’t pay in the same period. It can also be an obligation that a company has assumes in a period but has not received a corresponding invoice during the period.
What Does Accrued Liabilities Mean?
What is the definition of accrued liabilities? An accrued liability is an expense that a firm has incurred but has not covered yet. This is a key element of the accrual method of accounting, which records expenses when they are owed and revenues when they are earned.
A company may have accrued short-term or long-term liabilities for a number of reasons, including purchased goods and services, tax liabilities, payroll obligations or interest expenses on a loan repayment. Companies report accrued liabilities under accounts payable.
Let’s look at an example.
Company X closes its fiscal year on December 31. For 2020, the company asks Ernst & Young to audit the company’s results and verify that everything is reported accurately and in a proper manner. The cost of auditing is $30,000. When it completes the audit, Ernst & Young sends an invoice of $32,500 to Company X with an analysis of the actual hours spent on the auditing.
The amount of $30,000 is an accrued liability for Company X because it incurred auditing expenses from Ernst & Young in December and did not receive an invoice by the end of the year. The audit fee is recorded on its books by debiting expense and crediting the accrued liability account.
In February, the company receives the invoice from E&Y for an amount of $32,500. Upon paying the invoice in full, the company’s accountant records the additional audit fee expenses of $2,500 by debiting the expense account and crediting cash. He also makes a reversing entry to cancel the accrued liability of $30,000 by debiting the liability and crediting cash. Therefore, the liability account is zeroed out and the cash and expense accounts reflect the full payment of $32,500.
The importance of this series of entries is timing. The accrual had to be recorded at the end of year to reflect the obligation that the company owed to E&Y for the services that were being rendered. If this obligation weren’t shown on the financials, they would be misleading. Also, the company didn’t know that the services were going to be more than the estimate of $30,000. Thus, recording an accrual of $30,000 was correct at the time.
Define Accrued Liabilities: Accrued liability means a company has incurred an expense for a good or service but has not paid for it yet.