Unrecorded Liabilities: How One Company's Profit Was Overstated

Unrecorded Liabilities: How One Company's Profit Was Overstated

The year-end close showed a $180,000 profit. Three weeks later, a stack of December invoices proved it was closer to $25,000. The gap was unrecorded liabilities: costs the company had already incurred but had not yet put in its books.

Illustrative anonymized composite, drawn from recurring patterns rather than a single engagement. The firm named below was not involved in it. Every dollar figure is invented and rounded. Nothing here is guaranteed or predictive.

The company in this composite is a $4 million services business with a bank line of credit and an owner who budgets bonuses off the year-end number. A firm whose profile describes this kind of work is System Six, a Seattle bookkeeping and fractional CFO firm for companies with $1 million to $10 million in revenue. It is covered near the end, after the story. System Six is a paid featured member of Sam's List.

How Unrecorded Liabilities Hid Behind a Clean Close

The books closed by the 10th and the bank reconciled. Expenses were booked as bills were entered, and that was the weak point.

Under accrual accounting, an expense belongs in the period it was incurred, not the period the invoice was entered or paid. A December service billed on January 12 is a December expense.

Nobody was hiding anything. The bookkeeper recorded what had arrived, and what had not arrived did not exist in the system.

The limitation: a reconciled bank account proves cash is right. It says nothing about bills not yet paid or entered.

The Search for Unrecorded Liabilities: Where the Gaps Were

The finance lead noticed three vendor invoices dated before year-end in the January mail. That triggered a structured search, in the order below.

• Subsequent disbursements review. Every check, ACH and card payment in the first weeks of January, matched to the period the cost belonged to.
• Open purchase orders. Goods or services received in December but not yet billed.
• Unbilled professional fees. Legal, audit and consulting work performed but not yet invoiced, confirmed by asking the providers.
• Payroll and paid time off. Wages earned in December and paid in January, plus accrued vacation the company owed employees.
• Sales tax and other tax payables. Amounts collected or due but not yet remitted.
• Credit card statements. December charges that landed on a statement closing in January.

The limitation: a search reduces the risk of a miss but does not prove completeness. An invoice lost in a general inbox can still slip through.

The Adjustments: What the Profit Looked Like Before and After

The table lists what the search found. Every figure is invented and rounded.

Item found	Amount
Reported profit before adjustments	$180,000
Vendor invoices dated December, entered in January	($62,000)
Unbilled legal and audit fees for work done	($18,000)
Wages earned in December, paid in January	($41,000)
Accrued paid time off	($14,000)
December sales tax collected but booked as revenue	($9,000)
December credit card charges on a January statement	($11,000)
Total adjustments	($155,000)
Profit after adjustments	$25,000

The six adjustments add to $155,000, and $180,000 less $155,000 is $25,000. A 4.5 percent margin became less than 1 percent.

The limitation: not every line is a hard number. Paid time off and unbilled fees were estimates, and a reasonable preparer could land on different amounts.

Accounts Payable Cutoff: Why the Invoices Landed in the Wrong Month

Accounts payable cutoff is the rule that decides which period a bill belongs to. The test is when the goods or services were received, not the invoice date and not the date someone entered it.

The company had no written cutoff step. Bills were coded to whichever month they were entered in, and the operations team's knowledge of completed work never reached accounting.

The fix is a checklist item to date each early-period bill to its service period, plus a receiving log.

The limitation: cutoff controls depend on people following them. A busy month or a staff change can bring the gap back.

Accrued Expenses: The Costs No Invoice Will Ever Announce

Accrued expenses are costs the company owes but has not been billed for, and some never will be. Payroll is the plainest case: wages earned in December belong in December, even if paid in January.

Paid time off is similar. Many companies record earned vacation as an obligation, though treatment depends on company policy and applicable rules. Professional fees, bonuses and interest follow the same logic.

An accrual entry debits the expense and credits a liability, then reverses when the real bill arrives, so nothing is counted twice.

The limitation: accruals are estimates. Too light and profit is overstated again, too aggressive and it is understated, so discuss judgment calls with a CPA.

What the Overstated Profit Would Have Cost: Covenant and Bonus

The owner had already planned a $50,000 bonus pool based on the $180,000 figure. The bank line also carried a covenant, in this composite, requiring at least $100,000 of annual profit. At $180,000 the company passed. At $25,000 it did not.

The finance lead called the lender before the compliance certificate was due, shared the corrected numbers and asked about a waiver. In this composite the bank granted a one-time waiver, but lenders vary and nothing guarantees that outcome. The bonus pool was cut and deferred until cash allowed.

The limitation: loan documents define profit their own way, so read yours and ask the lender how it counts adjustments.

The Monthly Routine That Catches It Earlier

After the cleanup, the company moved the work from year-end to every month:

1. Bills entered during the first ten days after month end are reviewed and dated to the right period.
2. Operations submits a short receiving log of work completed and goods received but not billed.
3. An accrual checklist covers payroll, paid time off, professional fees, taxes, interest and card statements.
4. Accruals are entered and set to reverse the following month.
5. A subsequent-disbursements scan of the first weeks of the new month runs before reports go to the owner or lender.

The limitation: this adds a day or two to each close and needs a named owner, or the checklist goes unopened.

Where System Six Fits

System Six is based in Seattle, was founded in 2009 and has about 41 employees. It offers bookkeeping and fractional CFO work to small businesses with $1 million to $10 million in revenue. The firm was itself acquired by a searcher in 2021, and its profile says it helps organizations modernizing a finance function after an acquisition. Its monthly fixed fee starts at $800.

System Six did not work with the company in this composite, and nothing above describes its results. It is named because close processes and accrual checklists are work a bookkeeping and fractional CFO firm can set up, so ask whether that is in scope for you. System Six is a paid featured member of Sam's List.

The limitation, plainly: its profile shows a $1 million revenue minimum, so ask for references from companies like yours. A profile also cannot tell you whether the firm has handled your lender's covenants or your accrual policies.

Frequently Asked Questions

What are unrecorded liabilities?

Unrecorded liabilities are obligations a company owes at period end that are not in its books, such as late vendor invoices, earned but unpaid wages, unbilled professional fees and card charges awaiting a statement. They overstate profit until someone finds and records them.

How do you find unrecorded liabilities after the books close?

Review payments made just after period end, open purchase orders, receiving records and vendor statements. Ask service providers what they have done but not billed, and check payroll, taxes and card statements. This lowers risk but does not prove completeness, so repeat it monthly.

What is the difference between accrued expenses and accounts payable?

Accounts payable are bills you have received and recorded. Accrued expenses are costs you have incurred but not yet been billed for or recorded, such as earned wages or unbilled legal work. Accruals rely more on estimates.

Can overstated profit cause problems with a lender?

Yes. If a loan covenant depends on profit or a ratio built from it, a correction can put you out of compliance. Loan documents and lenders vary, but raising a correction early, with a fix in place, usually gives you more room than a late discovery.

If your last close showed a good number, ask this week what invoices and accruals landed after it, then compare the answer to the report. If the gap is bigger than you expected, browse fractional CFOs on Sam's List, including the firm above.

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About the author: Kimberly Green is cofounder of Sam’s List, a directory and matching platform for financial professionals.