Accrued liabilities, such as trade payables, work in reverse with trade receivables. They become a source of liquidity if the company can extend it. But, if many of them are due at the same time, it could drain the company’s cash and could lead to liquidity problems.
Definition of accrued liabilities
Accrued liabilities are unpaid expenses that have already been incurred. The most common example is accrued expenses, i.e., amounts owed by companies to suppliers for purchasing inputs on credit. The company has received goods or services but has not yet paid for them. The company records them in the liabilities of the balance sheet, which can appear in current liabilities or non-current liabilities.
Some examples of accrued liabilities are:
- Purchase of raw materials on credit (accrued expenses)
- Accrued advertising and promotional expenses
- Unpaid salary tax
- Accrued employee salaries and benefits
- Accrued interest on loan debt
- Accrued warranty expense
How companies report accrued liabilities in the balance sheet
The company records accrued liabilities in current liabilities or non-current liabilities, depending on when they are due. Accrual expenses such as purchases of raw materials on credit appear in current liabilities because payments are usually scheduled within one year from the date of the transaction. While some other accounts appear as non-current liabilities because they have a maturity of more than one year.
Accrued liabilities arise when companies adopt the accrual accounting method. But, for the cash method, this account won’t exist because the company records expenses when it has paid in cash.
The accrual method allows a company to report expenses even if it has not been paid in cash. When the company has received goods or services, it records expenses in the income statement (shareholders’ equity decreases). At the same time, it also recognizes accrued liabilities. Because stockholders’ equity decreases and liabilities rise at an equivalent nominal, the accounting equation remains balanced.
Let’s take a simple example.
In November, the company buys goods from suppliers for the amount of Rp100 and will pay them in January next year. For financial statements ending December, the company will record an expense of Rp100 and an accrued liability of Rp100.
Then, in January, the company spends cash (total assets decreases) amounted to Rp100 for payment. At the same time, the company also eliminates liability accrual account amounted to Rp100 (total liabilities decrease).
Why you need to check this account
Deferred payments are a source of cash for the company. As long as it’s not yet due, the company can use some money for other purposes. So, the longer the maturity, the more loose the company is in handling cash.
But, when many accrued liability accounts are due at the same time, they, of course, could drain a company’s cash.