What’s the difference between accrued expenses and accounts payable?

01The rule, and who sets it#

Under US GAAP, an expense belongs in the period in which the cost is incurred: when you receive the service or the goods, not when the bill arrives or the cash goes out. That rule comes from the accrual basis of accounting, which every set of GAAP financial statements uses. It starts to matter the first time anyone reads your monthly statements: an investor update, a lender’s covenant test, a 409A valuation or a due-diligence request.

Accounts payable and accrued expenses are the two ways that rule shows up on the balance sheet. If the bill is in hand, the cost goes to accounts payable at the billed amount. If it isn’t, the cost goes to accrued expenses at an estimate, and the estimate is replaced when the bill arrives.

02Side by side#

A useful test at month end: for every vendor who did work in the month, is there either a bill or an accrual? If neither, the month is understated.

• Evidence: AP has a vendor invoice; an accrual has an estimate and the support behind it (a contract, a usage report, hours from the firm).
• Amount: AP is exact; an accrual is your best estimate.
• Where it lives: AP sits in the bill-pay system, bill by bill; accruals sit in a month-end schedule.
• How it clears: AP clears when you pay; an accrual is reversed when the actual bill is recorded.
• How it’s reconciled: AP to the aging report; accruals to the schedule, line by line.

03Worked example: legal fees#

Your law firm works on financing documents through September. Their invoice for September won’t arrive until October 20. At September 30 the partner’s team tells you their September time is about $7,500. Accrue it, dated September 30. Debit side: legal fees $7,500. Credit side: accrued expenses $7,500. September now carries September’s legal cost.

On October 1 the accrual reverses automatically. Debit side: accrued expenses $7,500. Credit side: legal fees $7,500. On October 20 the actual bill arrives for $7,820 and is recorded as normal. Debit side: legal fees $7,820. Credit side: accounts payable $7,820.

Add up October’s legal fees: a $7,500 credit from the reversal and a $7,820 debit from the bill, net $320. That $320 is the difference between the estimate and the actual, and it lands in October, the month you learned it. September is not reopened, and the period you already reported still says what it said.

04Worked example: cloud usage#

Usage-based bills are the most common accrual at a software company. Your cloud provider invoices October’s usage in early November, but the billing console shows October’s running total on the 31st: $8,400. Accrue it at October 31. Debit side: hosting $8,400. Credit side: accrued expenses $8,400.

The accrual reverses on November 1, and when the invoice is recorded in November the two net to the true-up. If the provider charges your card automatically rather than sending a bill, the charge posts to the card in November and the reversal offsets it the same way. Without the accrual, October looks $8,400 cheaper than it was and November looks like a spike, which is exactly the pattern that makes a burn chart misleading.

05Why reversing entries#

A reversing entry undoes the accrual on the first day of the next period, so whoever records the real bill doesn’t need to know an accrual existed. They record the bill as normal, and the books sort out the difference. The alternative, recording the bill against the accrual account directly, works, but it depends on someone remembering, and a missed one leaves a stale accrual sitting on the balance sheet for months.

Either way, the accrued expenses account should be explained, line by line, at every month end. Anything older than a couple of months either has a bill that was recorded without clearing it, or was never going to be billed and should be released.

06What usually needs accruing#

The list is short for most startups, and it repeats every month. Keep it as a schedule with the vendor, the basis for each estimate and the amount, and the close becomes a matter of updating numbers rather than remembering vendors.

• Professional fees billed in arrears: legal, audit and review, consultants.
• Usage-based software and infrastructure billed after the month.
• Contractors who invoice after month end.
• Payroll for days worked but not yet paid, and the employer taxes on it.
• Interest on loans and venture debt, between payment dates.
• Bonuses and commissions earned but not yet paid.

07Accruals that aren’t accounts payable at all#

Two other balances are often confused with these. A prepaid expense is the mirror image of an accrual: you paid before you received the service (an annual software contract paid up front), so the cash went out first and the cost is released month by month from an asset. A received bill for a future service, such as next year’s subscription invoiced in December, is accounts payable on one side and a prepaid on the other; it is not an expense of December.

A commitment, such as a signed purchase order or a contract for work not yet started, is neither. Nothing has been received, so nothing is owed yet and nothing is booked. It belongs in your cash plan, not your balance sheet. Booking commitments as accruals overstates both the expense and the liability.