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Costs you owe but haven't paid can quietly inflate your profits, and the rules for recording them aren't the same on your financial statements as on your tax return.
The calendar flips to a new year, but some of last year's costs haven't shown up as bills yet. Interest kept building on your line of credit. Employees earned bonuses you won't pay until March. If those costs never make it onto your books, your financial statements tell a rosier story than reality, and your lenders, investors, and board are making decisions based on that story.
What Is An Accrued Expense?
An accrued expense is a cost your business has incurred but hasn't paid, and often hasn't been billed for, by the end of a reporting period. Under U.S. Generally Accepted Accounting Principles (GAAP), businesses using the accrual method record these costs when they happen rather than when cash goes out, so each period's expenses line up with the revenue they helped produce.
Common examples include:
- Interest on loans, which builds daily between payment dates.
- Wages, bonuses, payroll taxes, and benefits employees have already earned.
- Utilities, professional fees, and taxes owed for the period.
At period-end, an adjusting entry records the cost on the income statement and a matching liability on the balance sheet. Accrued interest, for instance, generally shows up as a current liability when it's due within a year (or within the operating cycle, if that's longer). One wrinkle: interest tied to building or producing certain assets may need to be capitalized rather than expensed.
Some accruals are simple math. Others, like bonuses or legal fees, call for estimates, and that's where judgment (and risk) comes in.
Accrued Expenses vs. Accounts Payable: What's The Difference?
Both are current liabilities, and the difference usually comes down to the invoice. Accounts payable (AP) covers bills you've received from vendors but haven't paid. Accrued expenses cover costs you owe but haven't been billed for yet, so the amount is often an estimate. When the invoice arrives, the amount typically moves from accrued expenses into AP.
Take December's electricity. You used it in December, but the utility won't bill you until January. On Dec. 31, that cost is an accrued expense. Once the bill lands, it's AP. (The invoice may be late. The expense isn't.)
How Should Accrued Expenses Appear On Financial Statements?
GAAP doesn't call for a footnote on every accrual. Materiality and the guidance tied to each obligation drive presentation, so significant accrued liabilities may be listed separately on the balance sheet or explained in the notes. A note on accrued compensation, for example, might state the year-end total, what it includes (salaries, bonuses, payroll taxes), and when it's expected to be paid.
Financial statements also need to disclose that management relies on estimates. Under the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 275, Risks and Uncertainties, additional detail may be required when an estimate could change materially in the near term.
Why Doesn't Every Accrued Expense Create A Tax Deduction?
Because book rules and tax rules don't always agree. Many businesses keep GAAP books on the accrual method but use the cash method for federal income tax. For tax years beginning in 2026, a business generally qualifies for the cash method if its average annual gross receipts for the prior three years don't exceed $32 million, according to IRS Revenue Procedure 2025-32. Other restrictions can apply.
Under the cash method, you generally deduct expenses when you pay them. That can defer taxable income, but it also pushes deductions for unpaid accruals into a later year. Accrual-method taxpayers face their own timing test. As IRS Publication 538, Accounting Periods and Methods, explains, a cost is generally deductible once the liability is fixed, the amount can be determined with reasonable accuracy, and economic performance has occurred. Some costs must be capitalized either way.
How Are Accrued Bonuses Treated For Tax Purposes?
Cash-method employers deduct bonuses when they're paid. Accrual-method employers can generally deduct bonuses in the year employees earn them when:
- The total obligation is fixed by year-end.
- The amount can be determined with reasonable accuracy.
- Payment happens within 2½ months after year-end (March 15 for calendar-year businesses).
Miss that window, and the bonus is generally treated as deferred compensation under Treasury Regulation section 1.404(b)-1T, which delays the deduction until the year employees include it in income.
Plan design matters, too. If unpaid bonuses revert to the company when someone leaves before payday, the liability may not be fixed at year-end. A bonus pool that reallocates forfeited amounts to the remaining employees can preserve the year-end deduction, an approach the IRS accepted in Revenue Ruling 2011-29, as summarized in this AICPA Tax Adviser analysis of pooled bonus arrangements.
Related parties add another layer. Bonuses owed to related parties who use the cash method generally aren't deductible until the recipient reports them as income. That typically includes C corporation shareholders owning more than 50% of the stock, directly or indirectly, and S corporation shareholders at any ownership level. Partnerships and limited liability companies (LLCs) bring their own complications, so these rules are worth reviewing with your business tax advisor.
Where Do Accrued Expense Errors & Fraud Show Up?
Estimates and timing leave room for honest mistakes: costs booked to the wrong period, accruals misclassified or left off entirely. Any of these can understate liabilities and overstate profits.
They also leave room for manipulation. Fictitious accruals can build a reserve that's quietly reversed later to boost earnings. Hidden invoices or lowball estimates can make the current period look better than it is. An external audit provides reasonable assurance, not absolute assurance, that financial statements are free of material misstatement, so strong internal controls carry real weight. If something already looks off, a forensic accounting review can help get to the bottom of it.
Close The Year With Numbers You Can Trust
Accurate accruals give owners, lenders, and investors a clearer view of how the business is really performing. A few things worth considering before year-end: a consistent closing checklist, a documented approach to estimates, and a fresh look at bonus plan terms while there's still time to adjust them.
GBQ's Assurance & Advisory and Tax & Advisory teams work together on exactly these book-tax questions, so your financial statements and your return tell a consistent story. Empowering growth is only a conversation away. Talk to an expert about your accrued expenses, disclosures, and bonus planning.
Frequently asked questions
Is an accrued expense a liability?
Yes. An accrued expense is recorded as a current liability on the balance sheet, with the related cost shown on the income statement for the period it was incurred.
What's the difference between accrued expenses and accounts payable?
Accounts payable covers invoices you've received but haven't paid. Accrued expenses cover costs you've incurred but haven't been billed for, which often requires an estimate.
Can a business use accrual accounting for its books and cash accounting for taxes?
Often, yes. For tax years beginning in 2026, businesses averaging $32 million or less in annual gross receipts over the prior three years may qualify for the cash method, subject to other rules.
When must accrued bonuses be paid to deduct them in the year earned?
For accrual-method employers, generally within 2½ months after year-end, which is March 15 for calendar-year businesses, along with other requirements.
