Accrued expenses, explained simply
If employees worked the last week of December but are paid in January, December’s profit should include that cost. Smaller companies often omit accruals, which overstates profit and understates liabilities.
Diligence identifies missing accruals by examining payments made after the period end and determining the period to which they relate.
An accrual that was missed
IllustrativeAlder Creek Manufacturing, year-end bonuses
The cost belongs to 2025 even though cash leaves in 2026.
Commonly missed accruals
| Accrual | Often missed? |
|---|---|
| Wages earned but not yet paid | Sometimes |
| Year-end bonuses | Often |
| Paid time off owed to employees | Often |
| Professional fees, such as legal and accounting | Often |
| Utilities and freight | Sometimes |
| Interest on loans | Rarely |
Worked example
Diligence finds two missing accruals at the December 2025 year end: $0.20 million of bonuses earned in 2025 and paid in March 2026, and $0.15 million of unused vacation owed to employees. Both reduce working capital. The bonuses also reduce LTM EBITDA. Because they were earned before closing but are paid after it, they are treated as a debt-like item for the seller’s account.
Alder Creek Manufacturing, Inc. is a fictional company. All figures are illustrative.
Why it matters in a deal
Missing accruals overstate profit and understate liabilities, so the buyer ends up funding the seller’s costs.
Red flags
- No accruals recorded at month end
- Accrued balances that never change
- Expenses consistently recorded when paid rather than when incurred