Liabilities and Accruals: What You Owe Before the Bill Arrives

Accrued liability

An accrued liability is an obligation a business has already incurred but has not yet paid or been billed for, so the amount is recorded from a calculation or an estimate rather than from an invoice. It sits beside the invoiced obligations in Accounts Payable and the customer deposits in Unearned Revenue as one of the liability accounts that only exist under accrual accounting.

Most owners think of what they owe as the stack of unpaid supplier invoices. That stack is real, and it lives in Accounts Payable. But it is the easy part, because someone else did the work of telling you the amount. The harder liabilities are the ones nobody invoices: the four days of wages your staff earned since the last payroll, the interest your loan has been quietly building since the last payment, and the repairs you will owe on products you sold this month under warranty. Those have to be found and booked by you, and a chart with nowhere to put them simply leaves them out.

Leaving them out does not make them go away. It moves the cost into a later month, so the month that earned the revenue looks better than it was and a later month looks worse. Under GAAP (Generally Accepted Accounting Principles) the expense belongs in the period it was incurred, and the liability that comes with it belongs on that period's balance sheet.

Structure

Liabilities are split by when they come due. Current liabilities are due within a year, or within the normal operating cycle if that is longer; long-term liabilities are due after that. Within current liabilities, the useful distinction for a small business chart is how the amount is known: invoiced, calculated, estimated, or received in advance.

Three things about this layout matter more than the exact numbers. First, Accounts Payable is its own account type in QuickBooks Online because bills post to it automatically; the accrued accounts are ordinary Other Current Liabilities that you post to by journal entry. Second, the accrued accounts are split by what they hold, so a lender reading the balance sheet can see wages owed separately from interest owed. Third, the long-term loan is shown in two rows, because the slice due in the next twelve months is a current obligation even though the loan is not.

Recording

The recording pattern for every accrual is the same: at month end, debit the expense for what was incurred and credit the liability for what is owed; when the cash goes out, debit the liability and credit cash. The expense is recorded once, in the month it belongs to. Figures are illustrative.

Say a shop pays staff every other Friday, and the month ends on a Tuesday. Four working days of wages, $6,400, have been earned but will not be paid until the next payroll run.

Interest works the same way with a calculation instead of a timesheet. A $120,000 loan at 7 percent builds $700 of interest a month whether or not a payment is due, so month end debits Interest Expense and credits Accrued Interest for $700, and the next loan payment clears the accrual.

A warranty provision is the estimated version. When products ship with a one-year warranty, the cost of future claims belongs with the sale, not with the month a customer calls. If experience says claims run about 2 percent of sales, a $40,000 sales month books $800 to Warranty Expense and Warranty Liability at the time of the sale. When a claim is honored later, the repair cost is debited to Warranty Liability, not to that month's expenses. The textbook treats this under contingent liabilities: an obligation is accrued when it is probable and the amount can be reasonably estimated, and disclosed in the notes when it cannot.

Unearned Revenue is the mirror image. A $5,000 deposit for a job not yet started is credited to Unearned Revenue when the cash arrives and moves to revenue only as the work is delivered. The obligation is not money but work, and until it is done the balance is a liability.

Reporting

All of this lands in one section of the balance sheet. The highlighted rows are the ones that exist only because the month-end entries above were made.

Without the highlighted rows, total current liabilities would read $35,590 instead of $48,490. The business would look $12,900 better off than it is, and next month's income statement would absorb costs that belong to this one. A lender comparing current assets with current liabilities would be working from the wrong number, which is one reason banks ask for accrual statements.

The income statement moves in step. Each accrual entry has one balance sheet account and one income statement account, so the $6,400 in Accrued Wages is matched by $6,400 more Wages Expense in the same month. The two statements cannot disagree about what the month cost.

Insight

Which liabilities need their own row depends on the business: a manufacturer needs a warranty provision, a contractor needs retainage payable, a restaurant needs tip and sales tax liabilities. See how each one sets them up in the industry guides built on this foundation, or check whether your chart has the liability accounts your month-end entries need.

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