What is Accounts Payable?
Definition: Accounts payable is defined as the amounts due to a company or business when they purchase goods or services from the suppliers on credit. Accounts payable AP shows all the outstanding amounts that the vendors or suppliers owe in exchange for the goods purchased by the company.
Accounts Payable is the account that represents the company’s obligation to pay off its short-term debts to the suppliers or creditors. When a company buys goods or services from a supplier on credit, it needs to be paid back quickly. This due amount is recorded in the books of accounts in the general ledger of the accounts payable department.
The balance of the accounts payable is shown on the liabilities side of the company’s balance sheet. It is so because the company is still liable to pay the same amount to its creditors. Any increase or decrease in the balance of Accounts payable is shown in the cash flow statements.
Accounts payable are generally the short-term debts due to the suppliers. The suppliers or vendors of the company will record this amount due in the accounts receivable of the books of accounts. It is one of the important amount figures for a company’s balance sheet.
If there is an increase in the accounts payable, it shows that the company is purchasing more goods and services on credit than paying cash for the same. On the other side, if the Accounts payable amount decreases in the financial period, it shows that the company is paying off its debts quickly.
Accounts Payable vs Accounts Receivable
Accounts payable is the amount that a company owes to its vendors, while on the other side, accounts receivable is the amount that is owed to the company. If a company transacts with another company on credit, this will be a part of accounts payable, while the other party to this transaction will record this in the account receivable.
Functions of Accounts Payable
In a company, the accounts payable departments have more responsibilities than just paying incoming bills and invoices. In large size companies, there is a separate department for the accounts payable. But in many small-size companies, the accounts payable and accounts receivable activities are combined. Therefore, the role of accounts payable is dependent on the size of the business.
The three basic functions, other than paying bills, of Accounts Payable includes:
1. Business Travel Expenses
In large-size businesses, if there is a lot of activity requiring the traveling of staff, these businesses may ask their AP departments to manage their travel expenses. This might include making bookings of the airline, car rental, and hotel reservations. The AP department then can process the requests and distribute the funds to cover the travel expenses. However, this completely depends on the controls of the company.
Then after the business travel, the AP is responsible for settling the funds distributed and funds spent on the travel. Therefore, the AP department will have a responsibility to process the travel reimbursement requests.
2. Internal Payments
The AP department can also be responsible for making reimbursements to the internal departments as well. They might have to control the distribution of sales tax exemption certificates and administrate and control the petty cash expenses. AP also handles the supply of sales tax exemption certificates to ensure that the business purchases are free from sales tax expense.
3. Vendor Payments
The AP department also manages and organizes the whole information of the vendor, be it the contact information, payment terms, or the Internal Revenue Service W-9 information. This information can be managed either manually or using any computer database system. It also handles the monthly aging analysis reports that show the current situation of the businesses’ liabilities.
Apart from these three basic functions, the AP department also develops strategies to reduce the cost of the business. An AP department is also a direct line contact between the vendor representatives and the company. So, a strong relationship with the vendors and company can benefit the business.
Recording of Accounts Payable
There must be a dual effect of any transaction in the double-entry bookkeeping system to make the balance sheet equal. While recording the Accounts payable in the accounts of accounts, the accountant credits the accounts payable account immediately when the bill or invoice is received.
On the other side, the expense account for the goods or services purchased on credit is debited. However, if any capital asset is purchased on credit, then the capitalized asset will get debited. Now, when they pay off the debts, the amount in the accounts payable gets decreased, and it is debited with the same amount. Here, the cash account is credited because the cash balance decreases because of the payment done by the company.
Other than the general ledger, if a company is using the indirect method, then any change in the accounts payable is also recorded in the cash flow statement. The net increase or decrease in this account will appear on the Cashflow From Operating Activities.
Example for Understanding the Bookkeeping of Accounts Payable
Suppose, business purchases office supplies for $500,000. Here, the AP department will record this transaction immediately after receiving the invoice for the same.
Now, the company receives the invoice. So, here the accountant will make a credit of $500,000 in accounts payable and a debit of $ 500,000 in the office supply expense account. Now, if the company pays offs these debts, then the accountant will debit with accounts payable with $500,000, and the cash account will be credited with $500,000.
If at one time, a company has many open payments due to its vendors, then all these outstanding payments will be recorded in the accounts payable. So, if anyone looks at the balance of the accounts payable, then it will show the total amount that a business owes to its vendors and short-term lenders. This total balance will appear on the liability side of the balance sheet.
Accounts Payable Process
The accounts payable department follows a process before paying the accounts payable to the vendors. Different steps involved in the process are-
- Receiving the bill
- Reviewing the bill details
- Updating records once the bill is received
- Making timely payment
For ensuring that the cash and assets of the company are safe, different internal controls are also suggested for the accounts payable process and they are-
- Preventing payment to a fraudulent invoice
- Preventing payment to an inaccurate invoice
- Preventing payment to a vendor invoice twice
- Being certain that all vendor invoices are accounted for
It is obvious now that accounts payable is the amount that a business or company owes to its vendors/suppliers for the goods and services it has received.
Understanding accounts payable and its management process is important for a business to manage its payable obligations effectively.
Now it is your turn to define accounts payable as per your understanding of the concept after going through this post? In case of any doubts about accounts payable and accounts receivable, feel free to ask us in the comment section below.