What Is an Accrued Expense?

An accrued expense, also known as accrued liabilities, is an accounting term that refers to an expense that is recognized on the books before it has been paid. The expense is recorded in the accounting period in which it is incurred.

Understanding Accrued Expenses

Since accrued expenses represent a company’s obligation to make future cash payments, they are shown on a company’s balance sheet as current liabilities. An accrued expense can be an estimate and differ from the supplier’s invoice that will arrive at a later date. Following the accrual method of accounting, expenses are recognized when they are incurred, not necessarily when they are paid.

An example of an accrued expense is when a company purchases supplies from a vendor but has not yet received an invoice for the purchase. Other forms of accrued expenses include interest payments on loans, warranties on products or services received, and taxes—all of which have been incurred or obtained, but for which no invoices have been received nor payments made. Employee commissions, wages, and bonuses are accrued in the period they occur although the actual payment is made in the following period.

Accrual vs. Cash Basis Accounting

Accrual accounting differs from cash basis accounting, which records financial events and transactions only when cash is exchanged—often resulting in the overstatement and understatement of income and account balances.

Although the accrual method of accounting is labor-intensive because it requires extensive journaling, it is a more accurate measure of a company’s transactions and events for each period. This more complete picture helps users of financial statements to better understand a company’s present financial health and predict its future financial position.

Accrued Expenses vs. Prepaid Expenses

Accrued expenses are the opposite of prepaid expenses. Prepaid expenses are payments made in advance for goods and services that are expected to be provided or used in the future. While accrued expenses represent liabilities, prepaid expenses are recognized as assets on the balance sheet. This is because the company is expected to receive future economic benefit from the prepayment.

On the other hand, an accrued expense is an event that has already occurred in which cash has not been a factor. Not only has the company already received the benefit, it still needs to remit payment. Therefore, it is literally the opposite of a prepayment; an accrual is the recognition of something that has already happened in which cash is yet to be settled.

Advantages and Disadvantages of Accrued Expenses

Advantages

Accrued expenses theoretically make a company’s financial statements more accurate. While the cash method is more simple, accrued expenses strive to include activity that may not have fully been incurred but will still happen. Consider an example where a company enters into a contract to incur consulting services. If the company receives an invoice for $5,000, accounting theory states the company should technically recognize this transaction because it is contractually obligated to pay for the service.

Accrued expenses also may make it easier for companies to plan and strategize. Accrued expenses often yield more consistent financial results as companies can include recurring transactions in their financial reports that may not yet have been paid. In addition, accrued expenses may be a financial reporting requirement depending on the company and their Securities and Exchange Commission filing requirements.

Disadvantages

Because of additional work of accruing expenses, this method of accounting is more time-consuming and demanding for staff to prepare. There is a greater chance of misstatements, especially is auto-reversing journal entries are not used. In addition, a company runs of the risk of accidently accruing an expense that they may have already paid.

Last, the accrual method of accounting blurs cash flow and cash usage as it includes non-cash transactions that have not yet impacted bank accounts. For a large company, the general ledger will be flooded with transactions that report items that have had no bearing on the company’s bank statement nor impact to the current amount of cash on hand.

Special Considerations

Reversing Entries

A critical component to accrued expenses is reversing entries, journal entries that back out a transaction in a subsequent period.

Accrued expenses are not meant to be permanent; they are meant to be temporary records that take the place of a true transaction in the short-term. Every accrued expense must have a reversing entry; without the reversing entry, a company risks duplicating transactions by recording both the actual invoice when it gets paid as well as the accrued expense.

Month-End/Year-End

Accrued expenses are prevalent during the end of an accounting period. A company often attempts to book as many actual invoices it can during an accounting period before closing its accounts payable ledger. Then, supporting accounting staff analyze what transactions/invoices might not have been recorded by the AP team and book accrued expenses.

For companies that are responsible for external reporting, accrued expenses play a big part in wrapping up month-end, quarter-end, or fiscal year-end processes. A company usually does not book accrued expenses during the month; instead, accrued expenses are booked during the close period.

Example of Accrued Expense

A company pays its employees’ salaries on the first day of the following month for services received in the prior month. So, employees that worked all of November will be paid in December. If on Dec. 31, the company’s income statement recognizes only the salary payments that have been made, the accrued expenses from the employees’ services for December will be omitted.

Because the company actually incurred 12 months’ worth of salary expenses, an adjusting journal entry is recorded at the end of the accounting period for the last month’s expense. The adjusting entry will be dated Dec. 31 and will have a debit to the salary expenses account on the income statement and a credit to the salaries payable account on the balance sheet.

When the company’s accounting department receives the bill for the total amount of salaries due, the accounts payable account is credited. Accounts payable is found in the current liabilities section of the balance sheet and represents the short-term liabilities of a company. After the debt has been paid off, the accounts payable account is debited and the cash account is credited.

The Bottom Line

Companies using the accrual method of accounting recognize accrued expenses, costs that have not yet been paid for but have already been incurred. Accrued expenses make a set of financial statements more consistent by recording charges in specific periods, though it takes more resources to perform this type of accounting. While the cash method of accounting recognizes items when they are paid, the accrual method recognizes accrued expenses based on when service is performed or received. 

What Is a 12B-1 Fee?

A 12b-1 fee is an annual marketing or distribution fee on a mutual fund. The 12b-1 fee is considered to be an operational expense and, as such, is included in a fund’s expense ratio. It is generally between 0.25% and 0.75% (the maximum allowed) of a fund’s net assets. The fee gets its name from a section of the Investment Company Act of 1940.

Understanding 12B-1 Fees

Back in the early days of the mutual fund business, the 12b-1 fee was thought to help investors. It was believed that by marketing a mutual fund, its assets would increase and management could lower expenses because of economies of scale. This has yet to be proven. With mutual fund assets passing the $10 trillion mark and growing steadily, critics of this fee are seriously questioning the justification for using it. Today, the 12b-1 fee is mainly used to reward intermediaries for selling a fund’s shares. As a commission paid to salespersons, it is currently believed to do nothing to enhance the performance of a fund.

In 2015, the Securities and Exchange Commission (SEC) began examining the use of 12b-1 fees to determine if the rules for charging these fees are being adhered to and the presence of such fees is being properly disclosed.

12b-1 Fee Broken Down

The 12b-1 fee can be broken down into two distinct charges: the distribution and marketing fee and the service fee. Total 12b-1 fees charged by a fund are limited to 1% annually. The distribution and marketing piece of the fee is capped at 0.75% annually, while the service fee portion of the fee can be up to 0.25%.

Use of 12b-1 in Broker-Sold Shares

Class B and class C shares of broker-sold funds typically have 12b-1 fees, but they may also be charged on no-load mutual fund shares and class A broker-sold shares.

Class A shares, which usually charge a front-end load but no back-end load, may come with a reduced 12b-1 expense but normally don’t come with the maximum 1% fee. Class B shares, which typically carry no front-end but charge a back-end load that decreases as time passes, often come with a 12b-1 fee. Class C shares usually have the greatest likelihood of carrying the maximum 1% 12b-1 fee. The presence of a 12b-1 fee frequently pushes the overall expense ratio on a fund to above 2%.

The Calamos Growth Fund is an example of a fund that carries a smaller 0.25% 12b-1 fee on its class A shares and charges the maximum 1% 12b-1 fee on its class C shares.

What 12b-1 Fees Are Used For

The distribution fee covers marketing and paying brokers who sell shares. They also go toward advertising the fund and mailing fund literature and prospectuses to clients. Shareholder service fees, another form, specifically pay for the fund to hire people to answer investor inquiries and distribute information when necessary, though these fees may be required without the adoption of a 12b-1 plan. Another category of fees that can be charged is known as “other expenses.” Other expenses can include costs associated with legal, accounting, and administrative services. They may also pay for transfer agent and custodial fees.

Failure to Meet Form 10-Q Filing Deadline

When a company fails to file a 10-Q by the filing deadline, it must use a non-timely (NT) filing. An NT filing must explain why the deadline has not been achieved, and it gives the company an additional five days to file. Companies are required to submit an NT 10-Q to request the extension and explain the delay.

As long as a company has a reasonable explanation, the SEC allows late filings within a specified time period. Common reasons why companies are not able to file on time include mergers and acquisitions (M&A), corporate litigation, an ongoing review by corporate auditors, or lingering effects from a bankruptcy.

A 10-Q filing is considered timely if it is filed within this extension. Failure to comply with this extended deadline results in consequences, including the potential loss of the SEC registration, removal from stock exchanges, and legal ramifications.

Components of SEC Form 10-Q

There are two parts to a 10-Q filing. The first part contains relevant financial information covering the period. This includes condensed financial statements, management discussion, and analysis on the financial condition of the entity, disclosures regarding market risk, and internal controls.

The second part contains all other pertinent information. This includes legal proceedings, unregistered sales of equity securities, the use of proceeds from the sale of unregistered sales of equity, and defaults upon senior securities. The company discloses any other information—including the use of exhibits—in this section.

Importance of SEC Form 10-Q

The 10-Q provides a window into the financial health of the company. Investors can use the form to get a sense of its quarterly earnings and other elements of its operations, and to compare them to previous quarters—thus tracking its performance.

Some areas of interest to investors that are commonly visible in the 10-Q include changes to working capital and/or accounts receivables, factors affecting a company’s inventory, share buybacks, and even any legal risks that a company faces.

You can use a close competitor’s 10-Q to compare that to a company in which you are invested, or considering to invest in, to see how it’s performing. This will give you an idea of whether it’s a strong choice, where its weaknesses are, and how it could stand to improve.

Other Important SEC Filings

The 10-Q is one of many reports public companies are required to file with the SEC. Other important and mandated filings include:

Form 10-K: The 10-K must be filed once per year and includes the final quarter of the company’s performance (replacing a fourth-quarter 10-Q). This report serves as a summary of the year, often containing more detailed information than an annual report, and must be filed within 90 days of the end of a company’s fiscal year. The 10-K generally includes a summary of the company’s operations, management’s financial outlook, financial statements, and any legal or administrative issues involving the company.

Form 8-K: This report is filed if there are any changes or developments to a business that didn’t make the 10-Q or 10-K reports. This is considered an unscheduled document and may contain information such as press releases. If a company disposes of or acquires assets, has announcements of executive hiring or departures, or goes into receivership, this information is filed with an 8-K.

Annual report: A company’s annual report is filed every year, and contains a wealth of company news including—but not limited to—general information about the company, a letter to shareholders from the CEO, financial statements, and an auditors report. This report is submitted a few months after the end of a company’s fiscal year. The report is available through a company’s website or investor relations team, and can also be obtained from the SEC.

Form 10-Q FAQs

What Is a 10-Q Filing?

A 10-Q filing is a report that all public companies must submit to the Securities and Exchange Commission (SEC) after the end of each of their first three fiscal quarters (hence the “Q”). The filing is submitted by filling out a Form 10-Q.

What Is the Difference Between a 10-K and a 10-Q?

The main difference between Forms 10-K and 10-Q lies in the frequency and the amount of info they contain. Form 10-K is an annual report, filed at the end of a company’s fiscal year. Filed just once, it summarizes all the data for the year, including the fourth quarter. In contrast, Form 10-Q is filed three times a year, at the end of a company’s fiscal quarter. It details financial info for that quarter.

Also, Form 10-K is an audited report. Form 10-Q generally is not.

Are Public Companies Required to File Form 10-Q?

Yes, all U. S. public companies issuing common shares of stock that trade on exchanges are required to file Form 10-Q. The date by which they have to file varies on the number of shares, expressed in terms of dollar worth, they have outstanding.

Must Review Reports Accompany Financial Statements in a 10-Q?

10-Qs generally are not audited or accompanied by accountants’ reports. SEC regulations prohibit companies from making materially false or misleading statements, or omitting material information to make disclosures not misleading. The SEC staff reviews 10-Qs and may provide comments to a company where disclosures appear to be inconsistent with the disclosure requirements or deficient in explanation or clarity.

What Is a 10-K?

A 10-K is a comprehensive report filed annually by a publicly-traded company about its financial performance and is required by the U.S. Securities and Exchange Commission (SEC). The report contains much more detail than a company’s annual report, which is sent to its shareholders before an annual meeting to elect company directors.

Some of the information a company is required to document in the 10-K includes its history, organizational structure, financial statements, earnings per share, subsidiaries, executive compensation, and any other relevant data.

The SEC requires this report to keep investors aware of a company’s financial condition and to allow them to have enough information before they buy or sell shares in the corporation, or before investing in the firm’s corporate bonds.

Understanding 10-Ks

Because of the depth and nature of the information they contain, 10-Ks are fairly long and tend to be complicated. But investors need to understand that this is one of the most comprehensive and most important documents a public company can publish on a yearly basis. The more information they can gather from the 10-K, the more they can understand the company.

The government requires companies to publish 10-K forms so investors have fundamental information about companies so they can make informed investment decisions. This form gives a clearer picture of everything a company does and what kinds of risks it faces.

The 10-K includes five distinct sections:

• Business. This provides an overview of the company’s main operations, including its products and services (i.e., how it makes money).
• Risk factors. These outline any and all risks the company faces or may face in the future. The risks are typically listed in order of importance.
• Selected financial data. This section details specific financial information about the company over the last five years. This section presents more of a near-term view of the company’s recent performance.
• Management’s discussion and analysis of financial condition and results of operations. Also known as MD&A, this gives the company an opportunity to explain its business results from the previous fiscal year. This section is where the company can tell its story in its own words.
• Financial statements and supplementary data. This includes the company’s audited financial statements including the income statement, balance sheets, and statement of cash flows. A letter from the company’s independent auditor certifying the scope of their review is also included in this section.

A 10-K filing also includes signed letters from the company’s chief executive officer and chief financial officer. In it, the executives swear under oath that the information included in the 10-K is accurate. These letters became a requirement after several high-profile cases involving accounting fraud following the dot-com bust.

Where to Find a 10-K

Notably, 10-K filings are public information and readily available through a number of sources. In fact, the vast majority of companies include them in the Investor Relations section of their website. The information included in a 10-K can be difficult to move through, but the more familiar investors become with the layout and the type of information included, it will likely become easier to identify the most important details.

10-K Filing Deadlines

Filing deadlines for the 10-K vary based on the size of the company. According to the SEC, companies with a public float—shares issued to the public that are available to trade—of $700 million or more must file their 10-K within 60 days after the end of their fiscal year. Companies with a float between $75 million and $700 million have 75 days, while companies with less than $75 million in their float have 90 days.

Forms 10-Q and 8-K

Along with the 10-K, the SEC requires that public companies regularly file forms 10-Q and 8-K.

Form 10-Q must be submitted to the SEC on a quarterly basis. This form is a comprehensive report of a company’s performance and includes relevant information about its financial position. Unlike the 10-K, the information in the 10-Q is usually unaudited. The company is only required to file it three times a year as the 10-K is filed in the fourth quarter.

The form 8-K though is required by the SEC whenever companies announce major events of which shareholders must be made aware. These events may include (but aren’t limited to) sales, acquisitions, delistings, departures, and elections of executives, as well as changes in a company’s status or control, bankruptcies, information about operations, assets, and any other relevant news.