Accounts payable (A/P) is the amount that a small business owes to third-party suppliers and vendors. It is a liability account in the balance sheet that shows the outstanding amounts that are yet to be paid. This article will teach you what accounts payable are and how you should account for them properly in the books.
Key takeaways
- In recording A/P, we debit the appropriate expense account, such as purchases and operating expenses, and credit A/P.
- For inventory purchases, we record cash discounts to Purchases Discounts, which reduces the amount that we have to pay.
- A/P has two primary sources: purchases of inventory on account and operating expenses.
Accounts Payable Journal Entries
Unlike accounts receivable (A/R), which is A/P’s counterpart, recording A/P journal entries is straightforward. To illustrate, let’s assume that we received a bill from Alpha Supplies for $1,000. The terms are 5/10, net 30.
Accounts payable don’t include loans from banks or other parties, which are classified as notes payable. Learn more about notes payable vs accounts payable.
Here are the journal entries upon receipt of the bill and at settlement.
Upon Receipt of the Bill
The date of the journal entry should be the billing date, not the date when the bill was physically delivered to you. The entry should look like this:
Debit | Credit | |
|---|---|---|
Purchases Accounts payable - Alpha Supplies | 1,000 | 1,000 |
Our example above is an inventory purchase transaction. But for the sake of illustration, let’s assume that we received an electric bill from ABC Electric Co. The entry should be:
Debit | Credit | |
|---|---|---|
Utilities expense Accounts payable - ABC Electric Co. | 1,000 | 1,000 |
In manual accounting, the entry should be posted in the A/P Subsidiary Ledger of Alpha Supplies. If you’re using accounting software, enter the bill in the system—and it will do the journal entry and posting for you automatically.
At Settlement
The journal entry for the settlement of A/P might differ if we’re taking the discount or not.
Assuming we take the discount, the journal entry should be:
Debit | Credit | |
|---|---|---|
Accounts payable - Alpha Supplies | 1,000 | |
Cash | 950 | |
Purchases discounts | 50 |
The account Purchases Discounts will be offset against gross purchases. Overall, we should be reporting net purchases of $950 if we take the discount.
Assuming we don’t take the discount, the journal entry should be:
Debit | Credit | |
|---|---|---|
Accounts payable - Alpha Supplies | 1,000 | |
Cash | 1,000 |
Not taking the discount and maximizing the term can be advantageous if you’re short of cash. Since purchases on account can be considered “free credit” because there are no interest charges, you may want to delay payment instead.
Sources of A/P
The common misconception is that all debts are accounts payable—and that is not always the case. Here are the two main sources of A/P.
1. Purchases on Account
When you purchase from suppliers and request it to be paid at a later date, this purchase gives rise to an A/P. These purchases should be from third parties like suppliers and vendors.
Purchases on account that can be considered as accounts payable are as follows:
- Inventory purchases
- Performance of services
- Purchase of office supplies
Payables arising from salaries and wages are not considered as accounts payable. Payroll liabilities should be credited to the Salaries and Wages Payable account instead. Other liabilities, such as loans payable, interest payable, tax liabilities, and dividends payable, are not considered as A/P.
2. Operating Expenses
Operating expenses are expenses necessary for the business but not directly related to the main products and services. In other words, they are incidental but essential to the business. Examples of operating expenses are as follows:
- Utilities
- Insurance
- Legal and accounting fees
- Rent
- Repairs and maintenance
These same expenses can also create accrued liabilities when the expense has been recognized, but no bill has been received at the end of a period. For instance, insurance expense is recognized over time and recorded as an accrued expense liability. When a bill is received from the insurance company, the accrued expense will be transferred to accounts payable.
Frequently Asked Questions (FAQs)
No, they are not considered an expense. Accounts payable is a liability account. However, A/P may arise from expenses such as purchases, which may be why some think that A/P is an expense.
If you receive a bill, the entry is a debit to purchases and a credit to accounts payable. At settlement, the entry is to debit accounts payable and credit cash.
Bottom Line
Knowing what accounts payable are can help small business owners understand the billing process and provide insight into cash outflows. Proper recording of A/P is crucial so that you don’t miss payments and incur late payment fees.
