Lesson 5 of 8
Owed, not paid
Accrued expenses and provisions charge a cost before any money moves. Caterpillar's product warranty liability stood at $1,626 million at the end of 2025.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- An accrued expense charges profit now for something that will be paid later, and creates a liability for the difference.
- A provision does the same for a cost whose amount and timing are both estimates, such as warranty or restructuring.
- These are the accruals where management has the most discretion, because nobody has yet sent an invoice to argue with.
The third timing case charges a cost before any money leaves. The work was done, the obligation exists, and the payment is in the future.
Some of these are precise. Interest owed on a loan at a known rate for a known period is arithmetic. Others are forecasts dressed as liabilities, and those are the interesting ones.
Caterpillar's product warranty liability, three year ends
- 31 December 2023$1,894m
- 31 December 2024$1,700m
- 31 December 2025$1,626m
The simple kind
Fen Street Bindery owed $2,400 of interest for the year and paid $1,800. The remaining $600 was charged to profit and credited to a liability called interest payable.
Accrued wages work the same way. A December payroll paid in January is a December cost, because the work happened in December. So does accrued vacation, accrued utilities and any bill that arrives after the year end for a service already consumed.
None of these involve much judgement. The rate is known, the period is known, and the arithmetic settles it.
The estimated kind
A warranty is different. When a machine is sold, the seller takes on an obligation to fix it if it fails, and nobody knows which machines will fail or what the repairs will cost.
The accounting answer is to charge the expected cost at the time of the sale, because that is the period the revenue belongs to, and to carry the estimate as a liability until claims are settled against it.
Caterpillar's fiscal 2025 10-K, filed on 13 February 2026, reports a product warranty liability of $1,626 million (Caterpillar Inc. FY2025 10-K, accession 0000018230-26-000008) at 31 December 2025, against $1,700 million (Caterpillar Inc. FY2025 10-K, accession 0000018230-26-000008) a year earlier and $1,894 million (Caterpillar Inc. FY2025 10-K, accession 0000018230-26-000008) at the end of 2023.
The company's own auditor treated this estimate as the single critical audit matter of the 2025 audit, and the filing describes how it is built: historical claim rates applied to the machines in the field and in dealer inventory, by model and by region, updated monthly.
Why the discretion matters
The point is not that companies do this. It is that the accounts cannot distinguish a genuine improvement in reliability from a change of view, and the only place to look is the movement in the liability against the movement in sales and in the installed base.
A liability that falls while the installed base grows is worth a paragraph of the note. A liability that falls while sales fall is usually just arithmetic.
Where these show in the cash flow statement
An increase in accrued liabilities is a positive adjustment in the operating section, because profit was charged for something that took no cash. A decrease is negative, because cash left to settle a cost charged in an earlier year.
That is the general rule for this whole timing case, and it is the mirror of the receivables rule from lesson three.
Check yourself
A December payroll is paid on 3 January. Which year carries the cost?
- January, because that is when the cash left
- December, because that is when the work was done
- It is split between the two
Show the answer
Answer: B.
Accrual accounting charges the period the cost was incurred. The liability carries it across the year end and the payment settles it without touching profit.Why is a warranty provision charged at the time of the sale rather than when repairs happen?
- To smooth reported profit
- Because the obligation arises from the sale, so it belongs in the period the revenue was recognised
- Because repairs are unpredictable
Show the answer
Answer: B.
Matching puts the cost with the revenue that created it. The consequence is that the charge is an estimate, since the repairs have not happened yet.A company's warranty liability falls while its installed base grows. What does that show?
- That reliability improved
- That the company is understating costs
- Neither on its own. It is a question for the warranty note, which discloses how the estimate is built
Show the answer
Answer: C.
A genuine improvement in failure rates and a change of view produce the same movement. The accounts cannot separate them, and the note is where the basis is described.Sources
- Caterpillar Inc., FY2025 Form 10-K, filed 13 February 2026, accession 0000018230-26-000008, for the product warranty liability at 31 December 2025, 2024 and 2023, and for the description of how the estimate is built.
- ASC 450, Contingencies, on recognising a loss contingency when it is probable and the amount can be reasonably estimated.
What this leaves out
- The Caterpillar figures are history, read from the filings for those fiscal years. They are not a statement about the company today and not a view on any security.
- The two-column warranty table uses invented round numbers so the effect on profit can be checked by hand. It is not Caterpillar's arithmetic.
- Warranty is one of many provisions. Restructuring, legal, environmental and self-insurance reserves each follow their own recognition and disclosure rules.
- Nothing here is advice about any security.