Understanding Accounts Payable AP With Examples and How to Record AP
Understanding Accounts Payable (AP): Examples and How to Record AP
Accounts payable (AP) or "payables" are a company’s short-term obligations to creditors or suppliers that have not been paid. They appear on the company’s balance sheet as current liabilities.
Another usage of "AP" refers to the business department responsible for making company payments to suppliers and creditors.
AP can be compared with accounts receivable.
Key Takeaways:
– AP is the amount owed to vendors for goods or services received but not yet paid.
– The accounts payable balance on the balance sheet represents the total amount owed to vendors.
– Changes in total AP from the prior period are reflected in the cash flow statement.
– Managing outstanding bills can improve cash flow.
Understanding Accounts Payable (AP):
A company’s total AP balance is shown on the balance sheet under current liabilities. AP must be paid within a specific period to avoid default. At the corporate level, AP refers to short-term payments due to suppliers. It is essentially a short-term IOU between businesses. The other party records the transaction as an increase to their accounts receivable.
AP is an important figure on a company’s balance sheet. An increase in AP means the company is buying more goods or services on credit. A decrease indicates that the company is paying off prior obligations faster than making new credit purchases. Managing AP is crucial for cash flow.
When using the indirect method to prepare the cash flow statement, the net increase or decrease in AP is shown in the top section, cash flow from operating activities. AP can be used to manipulate cash flow. For instance, management can delay payment of outstanding accounts to increase cash reserves temporarily.
However, this flexibility must be balanced with maintaining good relationships with vendors. It’s best practice to pay bills by their due dates.
Recording Accounts Payable:
Proper double-entry bookkeeping requires a debit and credit for all general ledger entries. To record AP, the accountant credits accounts payable upon receiving the bill or invoice. The debit offset goes to an expense account for the purchased item or service. Alternatively, the debit could go to an asset account if the item is a capitalizable asset. When the bill is paid, the accountant debits accounts payable to decrease the liability balance and credits the cash account to decrease the cash balance.
For example, if a business receives a $500 invoice for office supplies, the AP department records a $500 credit in accounts payable and a $500 debit to office supply expense. The expense debit flows through to the income statement despite not having made a cash payment. The company then pays the bill, resulting in a $500 credit to the cash account and a $500 debit to accounts payable.
A company may have multiple open payments due to vendors. All outstanding payments are recorded in accounts payable, reflecting the total amount owed. This total appears on the balance sheet. For instance, if the business also receives a $50 invoice for lawn care services, the combined entries in accounts payable would equal $550 before payment.
Accounts Payable vs. Trade Payables:
Although some use "accounts payable" and "trade payables" interchangeably, they refer to slightly different situations. Trade payables include money owed to vendors for inventory-related goods, such as business supplies. Accounts payable encompass all short-term obligations of the company.
For example, if a restaurant owes money to a food or beverage company, those items are part of trade payables. Obligations to other companies, like those cleaning staff uniforms, fall into the accounts payable category. Both fall under accounts payable.
Accounts Payable vs. Accounts Receivable:
Accounts receivable (AR) and accounts payable are opposites. Accounts payable represent money owed by the company to vendors, while accounts receivable represent money owed to the company by customers. When two companies transact on credit, one records an accounts payable entry, while the other records an accounts receivable entry.
Examples of Payables:
A payable arises when money is owed for services rendered or products provided but hasn’t been paid. This includes purchases on credit, subscriptions, or installment payments due after receiving goods or services.
Where to Find a Company’s Accounts Payable:
Accounts payable are listed on the balance sheet as a current liability since they represent funds owed to others.
How Payables Differ From Accounts Receivable:
Receivables are funds owed to the company for services rendered and are recorded as an asset. Accounts payable, on the other hand, represent funds owed by the company to others and are considered a type of accrual. For example, payments due to suppliers or creditors are accounts payable and are booked as liabilities.
Are Accounts Payable Business Expenses?
No. Some people mistakenly interpret accounts payable as routine expenses of a company, but that’s incorrect. Expenses are shown on the income statement, while payables appear as liabilities on the balance sheet.
The Bottom Line:
Accounts payable (AP) refers to a company’s obligations incurred during its operations and must be paid in the short term. AP is listed on the balance sheet as a current liability. Typical payables include supplier invoices, legal fees, contractor payments, and more.
Note: The text has been reviewed and edited for clarity and conciseness.
