Newburg | CPA Tax Brief (02/11/2022)

Newburg | CPA Staff Writer – David R. Natan, CPA, MST, CVA — February 4, 2022

During an acquisition, buyers need to be extra careful when reviewing interim internal accrual based financial statements for completeness and accuracy. Quite often the application of the more popular EBITDA (Earnings Before Interest, Taxes Depreciation and Amortization) multiples whether applied to an interim projected period or latest trailing twelve-month period may be distorted when dealing with interim financial periods.  For privately held companies, interim period closings are often not as accurate and complete as those that align with the company’s natural calendar or fiscal year-end and can distort or overstate the purchase price if all liabilities are not captured. Applying a thorough ‘Search for Unrecorded Liabilities’ test, can often be an integral piece to successful due diligence. The understatement of liabilities can result in inflated EBITDA and purchase price figure for the buyer.

So how do we perform a proper ‘Search for Unrecorded Liabilities’ when reviewing interim financial statements?

  • Obtain a detailed accounts payable aging and accrued expense detail that ties to the interim balance sheet period.
  • Review banking activity and cash disbursement details for 30 to 60 days after the interim close period.
  • Ensure you are making an adequate number of selections to get a sufficient amount of coverage over the testing.
  • Target the larger payments and more common vendor names with the goal of obtaining 80% or more coverage of the payments selected.
  • Request and review the selected payments with the supporting documents (e.g., suppliers or service provider invoices, credit card receipts, etc.) to determine whether the liabilities were incurred before or after the interim balance sheet date.
  • If the service or supply period relates to a period prior to the balance sheet date, trace this back to the accounts payable aging detail or accrued expense detail.
  • Inquire with the related personnel about any unrecorded invoices.
  • Document and total any disbursements that related to the balance sheet period and were not recorded within accounts payable.

When you are dealing with an interim period cutoff, we would also recommend going back to the prior calendar or fiscal year period that matches the tax return and perform similar steps with transactions to provide additional comfort and ensure no understatement of liabilities.

The Search for Unrecorded Liabilities will often be a natural biproduct if you have a well-planned out Net Working Capital Peg as part of the transaction. During the Letter of Intent and due diligence periods, the Buyer should ensure that they have a protective Net Working Capital Peg that very specifically addresses the expectations of where they expect current assets over current liabilities to fall. Layering on the Search for Unrecorded Liability procedures to the Accounts Payable when reconciling the Net Working Capital Peg is an important step to ensure adequacy. Acquiring a business that may not have adequate working capital and potential hidden liabilities will only put strain on your newly acquired venture.

The Newburg | CPA due diligence team can help you navigate these complexities and avoid surprises relative to your acquisition. Visit for more information.

Please feel free to contact us directly with any questions.

Newburg CPA, a Boston-based accounting firm can assist you. Contact us if you have questions.