Accounts Payable Meaning
Accounts Payable (AP) is an outstanding amount to be paid to suppliers, vendors, and service providers for their goods and services. This account in General Ledger marks the amount that companies owe to third-party service providers and must be paid within a short period.
Accounts payable is an instance in the case of accrual accounting. It has no existence in cash accounting, which only showcases the cash inflow and cash outflow. Accounts Payable is always considered a liability and is labeled under “current liabilitiesCurrent LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They're usually salaries payable, expense payable, short term loans etc..”
Table of contents
- Accounts payable (AP) is the amount to be paid to suppliers, vendors, and service providers for their goods and services.
- Accounts Payable is always considered a liability and is labeled under “current liabilities.”Businesses, however, require internal controls to look after the AP transactions.
- Receiving, reviewing, approving, and executing the payments are the four major steps of the process.
- Accounts Payable is a term opposite to Accounts Receivable (AR), which details the amount a company is to receive from different parties.
Understanding Accounts Payable
Accounts Payable (AP) indicates the amount a company has to pay within an accounting periodAccounting PeriodAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company's overall performance., missing which would lead to default. The AP account details the short-term payments due to be made to suppliers and service providers supporting a business. There are instances when companies do not pay cash upfront and prefer buying goods on credit. This outstanding amount is recorded as AP.
Although observed as an important part of General LedgerGeneral LedgerA general ledger is an accounting record that compiles every financial transaction of a firm to provide accurate entries for financial statements. The double-entry bookkeeping requires the balance sheet to ensure that the sum of its debit side is equal to the credit side total. A general ledger helps to achieve this goal by compiling journal entries and allowing accounting calculations. , AP is not confined to only companies purchasing things on credit. Instead, the examples of AP can be seen around in the daily usage of resources, including electricity, broadband, telephone, etc. Customers use the services and pay for the same towards the end of the month as per their respective billing cyclesBilling CyclesThe billing cycle is the time period between one billing statement and the next billing date that companies generate for its services and products sold to the customers. The cycle could be monthly, quarterly or even annually. .
The management, in some scenarios, decides to build heavy cash reserves. As a result, they keep the payments due for a longer period. Though they successfully build the cash reserve for the company, the outstanding amount keeps increasing, and the businesses have to repay a huge amount to suppliers and service providers at once. In addition, their relationship with the vendorsVendorsA vendor refers to an individual or an entity that sells products and services to businesses or consumers. It receives payments in exchange for making items available to end-users. They constitute an integral part of the supply chain management for providing raw materials to manufacturers and finished goods to customers., suppliers, and supporting service providers gets hampered at the same time.
Thus, to avoid such extreme impacts of delaying payments, the businesses are recommended to stick to the due dates. Organizations, however, require having internal controlsInternal ControlsInternal control in accounting refers to the process by which a company implements various rules, policies, or procedures to ensure the accuracy of accounting and finance information, safeguard the various assets of the business, promote accountability in the business, and prevent the occurrence of frauds in the company. to look after the AP transactions well and ensure there is no delay and no inaccurate/duplicate invoices are entertained. Such controls in the organizations provide a safe and secure protocol to be followed for making payments.
Accounts Payable Video
Role of Accounts Payable
As businesses are run on a large scale, not every purchase or sale can be done in cash. So, companies choose to purchase or sell on credit to conduct their businesses conveniently. This due amount enters the AP account. It helps the company strike a balance between paying too early and paying too late.
Accounts payable turnover plays an important role in this context as it acts as a fundamental metric to assess how quickly an organization pays its dues to creditors and suppliers. It also helps determine how well a business analyzes and plans its cash cycle.
Accounts Payable Process
Following a proper Accounts Payable process is a must to ensure the payment of accurate dues. When an organization handles a huge volume of payments due to be paid, there are chances that they miss out on verifying invoices, ending up making payments for inaccurate bills. As a result, it is important to carefully follow a series of steps before executing the bills/invoices.
#1 – Receive
The suppliers and vendors send the invoice/bill based on the quantity of goods and items purchased or services delivered. The receipt of the invoice gives organizations an idea of how much they are paying for the goods and services. The due date too is mentioned on the receipt.
#2 – Review
Most organizations miss out on checking the details on the invoice. Thus, reviewing the bills/invoices is highly recommended. In addition, the vendor’s name, authorization, date, and other information should be matched to the purchases made before making the payment.
#3 – Approve
Once the details are validated, and the documents are verified, organizations can approve the payment and order to execute the same.
#4 – Pay
Companies are expected to process the payments on time before or on the due date.
Let us consider the following accounts payable examplesAccounts Payable ExamplesAccrued expenses like as logistics, licensing, leasing, raw material procurement, job work, and so on are common examples of accounts payable. These accounts reflect the amount yet to be paid to the corresponding individual in order to settle the transaction. to understand how to calculate the amount:
Company A purchases raw materialsRaw MaterialsRaw materials refer to unfinished substances or unrefined natural resources used to manufacture finished goods. for producing leather jackets from Company B. The total purchase amount for the former is $39,000. However, A decides to make a cash payment worth $15,000.
As A already pays $15,000, the invoice received from Company B deducts the same from the total due amount.
The amount due to be paid = $39,000 – $15,000
Thus, the account payable amount of Company A = $24,000
From Walmart 2016 filing, we note that AP was $38,487 million in 2016 and 38,410 million in 2015.
Source: Walmart 2016 10K Filings
Accounts Payable vs Accounts Receivable
In the context of Accounts Receivable vs Accounts PayableAccounts Receivable Vs Accounts PayableWhile Accounts Receivable is the capital amount that the clients/customers owe to the business, Accounts Payable is the capital amount that the business owes to its suppliers. , AP is a term opposite to Accounts ReceivableAccounts ReceivableAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. (AR). While the former records the payment a company is liable to pay to its suppliers, vendors, and other resource providers, AR details the amount it is to receive from different parties.
For example, A purchases goods from B without paying cash upfront and is expected to make the payment in 30 days. For B, which is to receive the amount, the record is maintained under the AR account, while A records the same amount under the AP label as it is the due amount for it.
Frequently Ask Questions (FAQs)
AP is an amount due to be paid by an organization to its supplier and vendors when purchases are made on credit. It is recorded under the current liabilities section of General Ledger. AP exists solely in the case of accrual accounting and not in cash accounting, as the latter is expressed only in terms of cash inflow and cash outflow with no account of what is to be paid or received.
AP can either be a credit balance or a debit balance. It is a credit entry when organizations are yet to pay vendors/suppliers for products and services they purchased on credit. On the other hand, if a company pays one of its vendors or suppliers, it makes a debit balance of that amount to decrease the credit balance accordingly.
AP is a liability as it indicates the amount due to be paid by businesses for the goods and services they buy from a third party.
This article has been a guide to Accounts Payable and its Meaning. Here we explain Accounts Payable Liability, its process, and its role in the business. You may learn more about financing from the following articles –