Accounts on a business's balance sheet include assets, liabilities and equity. Assets may be thought of as the economic resources that the business uses to produce its revenue. Liabilities are the debts it owes. Equity is the claim that the business's owners have on its assets. "Accounts Payable" and "Accrued Expense" are liabilities on the balance sheet. The difference between them is the manner in which their existences are recognized on the accounts.
Accrual Basis Accounting
Except in certain small businesses, most accounting is conducted on an accrual basis. That means the accountant chooses to recognize costs and revenues as they occur by immediately recording the transactions on the accounts. For example, a business might make a sale on credit—with only an expectation of a cash payment a month later—but recognize the sale immediately rather than when the payment is received.
Recognition means the recording of a transaction. Under accrual basis accounting, recognition should occur at the time the transaction occurs if it meets two criteria. First, the transaction must be complete. For example, a business may not recognize a sale until it has transferred the sold item to the customer. Second, the sum in question must be collectible, meaning the other party must be trustworthy when it comes to payment.
Accrued expenses are recognized at the end of the accounting period through what are called adjusting entries. Adjusting entries are used to recognize transactions that have occurred but for which no invoices have been sent out. For example, interest piling up on a debt instrument held by the business would be recognized as accrued revenue in an adjusting entry even if no payment will be received until months later. Accrued expenses are those that accumulate in this manner, including such items as utilities and salaries to be paid to employees.
In contrast to accrued expenses, accounts payable are debts for which invoices have been received. A business that purchases—on credit—goods intended for sale would recognize the liability from that transaction as an account payable.
Alan Li started writing in 2008 and has seen his work published in newsletters written for the Cecil Street Community Centre in Toronto. He is a graduate of the finance program at the University of Toronto with a Bachelor of Commerce and has additional accreditation from the Canadian Securities Institute.