Differences Between Accrued and Deferred Expenses

Accrued and deferred expenses represent the two possibilities that can occur due to timing differences under the matching principle.

Learning Objective

Explain the difference between accrued expenses and deferred expenses

Key Points

An accrued expense is a liability that represents an expense that has been recognized but not yet paid.
A deferred expense is an asset that represents a prepayment of future expenses that have not yet been incurred.
Oftentimes an expense is not recognized at the same time it is paid. This difference requires a business to record either an asset or liability on its balance sheet to reflect this difference in timing.

Terms

matching principle
Expenses should be matched with revenues.
deferred expense
A deferred expense or prepayment, prepaid expense, is an asset representing cash paid out to a counterpart for goods or services to be received in a later accounting period.
accrued expense
Accrued expense is a liability with an uncertain timing or amount, the reason being no invoice has been received yet.
accrued revenue
income recognized before cash is received

Full Text

Expenses

Accrued expenses and deferred expenses are two examples of mismatches between when expenses are recognized under the matching principle and when those expenses are actually paid. Both are represented on the company's balance sheet .

Balance Sheet

Accrued and deferred expenses are both listed on a company's balance sheet.

Accrued Expense

An accrued expense is a liability that represents an expense that has been recognized but not yet paid. Not every transaction requires an immediate exchange of cash for goods and services. Sometimes, especially when there is a prolonged history of ongoing transactions between two parties, formal invoicing and payment requirements can occur after the expense associated with the transaction has been recognized.

For example, assume a reseller receives goods from a supplier that it is able to immediately resell. However, the billing for those goods does not require payment for another month. Since the supplier delivered the goods and the reseller already generated revenues from the sale of those goods, it must recognize the associated expense. So the associated expense must be listed as a liability to be paid at some point in the future.

Deferred Expense

A deferred expense is an asset that represents a prepayment of future expenses that have not yet been incurred. Deferred expense is generally associated with service contracts that require payment in advance.

For example, assume a company enters into a legal services contract that requires an upfront payment of $12,000 for a year of services. The service has not yet been delivered, so the business cannot recognize the expense yet. So the business will record a $12,000 deferred expense asset. The provider then delivers on his service each month, requiring the business to recognize the associated expense. As a result, the business must recognize $1000 in expenses each month and decrease the value of the deferred expense asset by that amount.

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Impact of the Operating Cycle on the Income Statement

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