What is an Accrued Cost?

Accrued cost is the cost of goods or services received or incurred during a period, when the lack of a supplier billing forces the buyer to accrue the related cost. The lack of a supplier billing is typically because the invoice is in transit, and does not arrive from the supplier until after the books have been closed for the reporting period.

Accrued costs are not used in a business that operates under the cash basis of accounting, since it only records transactions when there is a transfer of cash. In a cash basis system, costs are recorded when they are paid, which tends to delay the recognition of costs.

How to Record an Accrued Cost

A cost is accrued with a journal entry that includes the buying company's best estimate of the cost of the goods or services received. This information may come from an authorizing purchase order. This entry is set up as a reversing entry, so that it is automatically backed out of the accounting system in the next reporting period, when the supplier invoice will presumably arrive.

Accrued Cost Best Practices

There are several best practices associated with the use of accrued costs, which are as follows:

Base on a materiality threshold. Though the use of accrued costs does result in more accurate financial statements, they also require a considerable amount of work to research and track. Consequently, most organizations only accrue costs when the amounts in question are above a materiality threshold; below that threshold, it is not cost-effective to record them.
Review periodically. A business should conduct an annual review of the accrued cost entries that it has made, to see if they are sufficient; it may be necessary to increase or decrease the number of these entries.
Use a standardized set of accruals. It is quite common to only employ a certain number of accruals in each reporting period. These accruals are listed in the closing procedure, to ensure that only an authorized set of these accruals are recorded. This ensures a high degree of consistency in the production of financial statements.

Example of Accrued Cost

As an example of an accrued cost, a company receives goods from a supplier on the last day of the month, for which it will be billed $10,000. The supplier's invoice has not yet arrived when the company closes its books for the month, so the controller creates an accrued cost with a $10,000 debit to the inventory account and a credit to the accrued liabilities account. At the beginning of the next month, this entry is reversed, and the supplier invoice is recorded when it arrives.