Accrued Expenses Change: Working Capital in CFO

Key Takeaways

• Accrued liabilities cover expenses recorded on the income statement before the related cash has been paid.
• A rising accrued balance is a source of cash; a falling balance is a use of cash, like accounts payable.
• ASC 230 groups accrued change among "other operating liabilities" in the indirect method reconciliation.
• Year-end accruals can swing the line sharply, so the four-quarter trend matters more than a single period.

What It Is

Accrued expenses are short-term operating liabilities for goods or services consumed but not yet billed by the supplier or settled with cash. Examples include accrued payroll, payroll taxes, bonuses, employee benefits, interest, utilities, professional fees, and rent.

Under the indirect method governed by ASC 230, the operating section reconciles net income to operating cash by reversing non-cash items and adjusting for changes in operating assets and liabilities. The change in accrued expenses sits among those working capital lines, separately from accounts payable, deferred revenue, and income taxes payable.

The Intuition

When a company runs payroll on January 5 for work performed December 26 to January 1, the December portion belongs to the prior year. Accounting accrues that payroll as an expense in December and a liability on the December balance sheet. No cash has moved yet.

The cash flow statement bridges that gap. The income statement records the expense, but cash leaves only when the paycheck clears in January. The accrued liability buildup at year end adds back to net income to convert accrual expense into cash paid.

The same logic applies to interest, bonuses, vacation, and utilities. Each is an expense before it is a cash payment. The accrued change line aggregates the timing gap across all such items.

How It Works

The indirect method mechanics:

Net income
+ Non-cash items (D&A, SBC, deferred tax)
+/- Change in AR
+/- Change in inventory
+/- Change in AP
+/- Change in accrued expenses  (+ if accruals increased; - if decreased)
+/- Change in deferred revenue
= Cash from operating activities

Many companies present a single "accrued and other liabilities" line. The supporting footnote breaks the balance into payroll, interest, taxes other than income, restructuring reserves, and contingent obligations. EY and KPMG guides recommend reading the footnote to identify which categories are driving the year-over-year change.

Restructuring reserves recorded as accruals settle in cash later. A reserve buildup is a non-cash charge that flows through accrued liabilities and adds to CFO. The cash exits when severance and lease termination payments hit, often in a later period.

Worked Example

A services firm reports:

Year 1                          Year 2
Operating expenses   $800m           $920m
Accrued expenses (end) $90m          $130m

Accrued expenses rose by $40m, lifting CFO by $40m.

Net income                $130m
+ Non-cash items           $50m
+/- AR change               $0
+/- Inventory change        $0
+/- AP change              $20m
+ Increase in accruals     $40m
CFO                       $240m

If $30m of the accrual increase relates to a restructuring reserve booked this year but payable next year, only $10m is recurring timing. Investors should expect a $30m drag in the following period as the reserve unwinds in cash. Reading the accrued footnote separates timing benefits from one-time reserve effects.

Common Mistakes

1. Aggregating with AP. Some statements lump AP and accruals together. The trend often hides different stories; ask for the disaggregated footnote.
2. Missing restructuring. A reserve build is non-cash and lifts CFO. The cash payment shows up months or years later as a drag when the reserve unwinds.
3. Ignoring year-end seasonality. Bonus accruals and tax accruals peak in Q4 and settle in Q1. The change line can swing sharply quarter to quarter while annual cash conversion looks fine.
4. Reading the sign wrong. An increase in accrued liabilities is a positive number in operating activities. Flipping the sign double counts the drag.
5. Overlooking contingent liabilities. Litigation and tax reserves recorded as accruals add to CFO when recognized and subtract when paid. Footnotes often disclose expected settlement dates.

Frequently Asked Questions

What is accrued change cash flow in simple terms? It is the adjustment that converts accrual operating expenses into cash actually paid. A rising accrued balance adds to operating cash; a falling balance subtracts.

How does the accrued change affect investment decisions? A persistent CFO lift from rising accruals is a quality flag if the underlying obligations have to settle later. Investors check the footnote for restructuring, litigation, and bonus reserves.

What is a real-world example of an accrued expenses change? A firm that announces a $200 million restructuring in Q4 records the charge through the income statement and an accrued reserve on the balance sheet. CFO that quarter benefits; the cash drag appears as severance payments roll out over the next year.

How can investors avoid being misled by accrued changes effectively? Compare the change line to the disaggregated footnote, watch for unusual reserve activity, and average four quarters before drawing conclusions about run rate.

How is accrued expenses change different from AP change? AP usually covers trade payables for invoices received from suppliers. Accrued expenses cover obligations recognized before any invoice arrives, like payroll, interest, utilities, and reserves.

Sources

1. FASB. ASU 2016-15, Statement of Cash Flows (Topic 230). https://storage.fasb.org/ASU%202016-15.pdf
2. EY. Financial Reporting Developments, Statement of Cash Flows. https://www.ey.com/content/dam/ey-unified-site/ey-com/en-us/technical/accountinglink/documents/ey-frd42856-05-21-2025_.pdf
3. KPMG. Statement of Cash Flows Handbook (US GAAP, September 2024). https://kpmg.com/kpmg-us/content/dam/kpmg/frv/pdf/2024/handbook-statement-cash-flows.pdf
4. BDO. Statement of Cash Flows Under ASC 230 Blueprint. https://arch.bdo.com/Statement-of-Cash-Flows-Under-ASC-230
5. Deloitte DART. Form and Content of the Statement of Cash Flows. https://dart.deloitte.com/USDART/home/codification/presentation/asc230-10/roadmap-statement-cash-flow/chapter-3-format-presentation/3-1-form-content-statement-cash

Disclaimer

This article is educational content only and is not financial advice. Nothing here is a recommendation to buy, sell, or hold any security. Consult a licensed advisor before making investment decisions.