At the end of a reporting period, most businesses have accumulated operating costs that won’t be paid until the next period. If your business prepares financial statements under U.S. Generally Accepted Accounting Principles (GAAP), certain unpaid costs may need to be reported as accrued expenses.

Overlooking accrued expenses can understate your business’s liabilities and overstate its profits. Accurate bookkeeping requires understanding which obligations should be reported on your financial statements and why recognizing an expense for accounting purposes doesn’t necessarily result in an immediate tax deduction.

What Are Accrued Expenses?

Businesses that issue GAAP financial statements use the accrual method of accounting. Accrual-basis accounting generally requires recognizing expenses when they’re incurred, regardless of when they’re paid.

At the end of an accounting period, your business may have incurred expenses during the current period that haven’t yet been paid or recorded in its financial statements. These unrecorded expenses require adjusting entries.

For example, if your business borrowed money to finance operations or capital assets, it accumulates interest costs daily. An adjusting entry may be necessary at the end of the accounting period to record the interest accumulated during that period.

Interest payable generally appears on the balance sheet as a current liability if it’s due within one year or the operating cycle, whichever is longer. The related cost generally appears on the income statement as interest expense, although interest incurred during the construction or production of qualifying assets may need to be capitalized.

Other common accrued expenses include:

• Taxes
• Utilities
• Professional fees
• Employee wages
• Bonuses
• Employee benefits

By recording accrued expenses, a business matches revenue earned during an accounting period with the related expenses incurred during that period. While reporting some accrued expenses, such as accrued interest, may be relatively straightforward, other accruals may require estimates.

Reporting Significant Accrued Liabilities

GAAP doesn’t require a separate footnote describing every accrued expense or estimation method. Presentation and disclosure depend on materiality and the accounting guidance applicable to the underlying obligation.

Significant accrued liabilities may warrant separate presentation on the balance sheet or additional information in the financial statement footnotes.

For example, a business might provide the following disclosure for accrued wages and benefits:

As of December 31, 2026, the business has accrued $300,000 for wages and related benefits, representing employee compensation earned but unpaid as of the balance sheet date. The accrual includes salaries, bonuses and payroll taxes. These amounts are expected to be paid in the first quarter of the following fiscal year. Management regularly reviews and adjusts the accruals based on actual compensation and obligations.

Businesses must also disclose their use of estimates in preparing financial statements. Additional disclosure may be required when a significant estimate is subject to uncertainty and could change materially in the near term. Other guidance may require disclosures about particular obligations or material changes in estimates.

Understanding Book-Tax Differences for Accrued Expenses

Some businesses apply different rules for recognizing income and expenses for tax purposes.

Certain small businesses can choose to use cash-basis accounting for federal income tax purposes. For tax years beginning in 2026, the inflation-adjusted gross receipts threshold is $32 million in average annual gross receipts over the previous three tax years. Eligibility may be subject to additional rules and restrictions.

If your business uses cash-basis accounting for tax purposes, some expenses recorded on its GAAP financial statements may not be deductible during the same tax year.

Under the cash method, businesses generally report income when it’s actually or constructively received and deduct expenses when they’re paid, rather than when they’re incurred under the accrual method.

Using cash-basis accounting for tax purposes may defer taxable income, but it can also delay deductions for unpaid expenses. Exceptions apply, including rules requiring certain costs to be capitalized.

Special Tax Rules for Accrued Bonuses

Special tax rules apply to accrued employee bonuses.

Cash-basis employers generally must deduct bonuses in the year they’re actually paid, regardless of when they’re earned. Accrual-basis employers, however, can generally deduct accrued bonuses in the year employees earn them if applicable requirements are satisfied, including:

• Bonus amounts are fixed obligations by the end of the tax year.
• Bonus amounts are reasonably determinable.
• Bonuses are paid within 2½ months after the end of the tax year, generally March 15 for calendar-year businesses.

If a business delays bonus payments beyond this period, the deduction is generally deferred until the year the employee includes the payment in income, typically the payment year, under the deferred compensation rules.

How Bonus Plan Terms Can Affect the Deduction

The terms of a bonus plan also matter.

For example, requiring employees to remain employed through the payment date may prevent a year-end deduction if forfeited bonuses revert to the employer.

One possible workaround is establishing a bonus pool. If the other requirements are satisfied, employers may deduct bonuses in the year they’re earned as long as any forfeited bonuses are reallocated among the remaining employees in the pool.

Under this type of plan, the aggregate bonus amount is fixed at year-end even though the amounts allocated to individual employees may not be determined until the payment date.

The favorable tax treatment for deducting accrued bonuses may also be limited by related-party rules. Bonuses owed to cash-basis related parties generally aren’t deductible until the recipients include them in income, typically when paid.

In general, this applies to shareholders who directly or indirectly own more than 50% of the value of a C corporation’s outstanding stock and to S corporation shareholders regardless of ownership percentage.

These rules can be complicated, particularly for partnerships and limited liability companies, so contact your tax advisor to discuss the appropriate treatment for your situation.

Common Errors and Risks With Accrued Expenses

Reporting accrued expenses can be challenging and requires meticulous recordkeeping, especially when a business follows different rules for recognizing expenses for financial reporting and tax purposes.

Errors and omissions may occur when estimating expenses or matching expenses to the proper accounting period, potentially resulting in understated or overstated liabilities. Businesses may also misclassify accrued expenses, creating confusion in their financial reporting.

Accrued expenses can also be vulnerable to fraud schemes.

For example, fake accruals for nonexistent expenses may be used to create a reserve that can later be reversed to inflate future profits. Alternatively, management might hide bills or manipulate estimates to avoid recognizing accrued expenses in the current period, artificially inflating profits.

External audits can help detect these schemes, but they provide reasonable, rather than absolute, assurance that financial statements are free of material misstatement due to fraud or error. Your accountant can also recommend antifraud controls to strengthen your defenses.

Strengthen Your Year-End Review

A consistent closing process helps ensure your financial statements accurately reflect unpaid obligations.

Giving accrued expenses the attention they require can provide owners, lenders and investors with a clearer picture of your business’s profitability and financial health.

Contact TRP Sumner PLLC

This article is intended for general informational purposes only and should not be considered accounting, tax, or financial advice. The appropriate accounting and tax treatment of accrued expenses depends on the specific facts and circumstances of each business. Rules and requirements may vary based on accounting method, entity structure, and other factors. Consult your accountant or tax advisor regarding the appropriate treatment for your situation.