Business operations produce revenues and also incur expenses. In a given time period, the difference between its revenues and expenses is net income if positive or a net loss if negative. Determining when to record expenses is one of the most important topics in accounting. Both discretionary and non-discretionary accrued expenses exist only under accrual-based accounting.
Cash and Accrual Bases
Cash and accrual bases are the most popular accounting methods. Cash-basis accounting records transactions when cash or cash equivalents are either received or paid out, whereas accrual-basis accounting records the same transactions when they occur. For example, if a business makes a sale on credit and collects the sum a month later, an accrual-basis accountant records the sale there and then while a cash basis accountant records it a month later.
Accrual basis is the much more popular and useful basis for accounting. Under accrual-basis accounting, transactions are recorded at the times of their occurrence as long as collection of owed sums is reasonably assured.
Expenses are expenditures made by businesses that produce benefits, most often related to the production of revenues, for the business at the time of their occurrence. Accrued expenses are expenses that have occurred but are still unpaid. Examples of accrued expenses include wages to be paid and utility bills. Accrued expenses only exist on an accrual basis since cash-basis accounting would not recognize them until they were paid.
Discretionary Accrued Expense
Non-discretionary expenses refer to expenses that the business is obligated to pay. Non-discretionary accrued expenses refer to expenses that the business is obligated to pay but has yet to pay. Both utility bills and wages to be paid to employees count as non-discretionary accrued expenses. Discretionary accrued expenses are expenses that the business is not obligated to pay but considers to have been incurred and not yet paid. Examples of discretionary accrued expenses are rare, but bonuses to be paid to management are an excellent example.