Neglecting to record your unpaid expenses can lead to accounting confusion. A typical business pays many expenses after the period in which the expenses are recorded — these are called unpaid expenses.
Some examples of unpaid expenses include the following:
A business hires a law firm that does a lot of legal work during the year, but the company doesn’t pay the bill until the following year.
A business matches retirement contributions made by its employees but doesn’t pay its share until the following year.
A business has unpaid bills for telephone service, gas, electricity, and water that it used during the year.
Accountants use three different types of liability accounts to record a business’s unpaid expenses:
Accounts payable: This account is used for items that the business buys on credit and for which it receives an invoice (a bill). For example, your business receives an invoice from its lawyers for legal work done. As soon as you receive the invoice, you record in the accounts payable liability account the amount that you owe. When you pay the invoice, you subtract that amount from the accounts payable account, and your cash goes down by that amount.
Accrued expenses payable: A business has to make estimates for several unpaid costs at the end of the year because it hasn’t yet received invoices for them. Examples of accrued expenses include the following:
Unused vacation and sick days that employees carry over to the following year, which the business has to pay for in the coming year
Unpaid bonuses to salespeople
The cost of future repairs and part replacements on products that customers have bought and haven’t yet returned for repair
The daily accumulation of interest on borrowed money that won’t be paid until the end of the loan period
Without invoices to refer to, you have to examine your business operations carefully to determine which liabilities of this sort to record.
Income tax payable: This account is used for income taxes that a business still owes to the IRS at the end of the year. The income tax expense for the year is the total amount based on the taxable income for the entire year. Your business may not pay 100 percent of its income tax expense during the year; it may owe a small fraction to the IRS at year’s end. You record the unpaid amount in the income tax payable account.
A business may be organized legally as a pass-through tax entity for income tax purposes, which means that it doesn’t pay income tax itself but instead passes its taxable income on to its owners. The example mentioned here is for a business that is an ordinary corporation that pays income tax.
