Definition of Accounts Payable (A/P)
Accounts payable (AP) is money owed by a company for goods and services purchased on credit to its vendors or suppliers. For instance, when you buy raw materials on credit, you are liable to pay the suppliers. This accounting entry appears on the balance sheet under current or short-term liabilities. Accounts payable are different than notes payable, which are debts created by formal legal documents such as a promissory note. Some may also refer to accounts payable as trade payables.
How to Record Accounts Payable?
The journal entry of an account payable item is a credit recording. This is because accounts payable are a liability account and hence are credited. For example, when you receive an invoice from your vendor after they have completed their services for you, you will credit the balance as Accounts Payable and debit the account after payment. Your total credit balance must be equal to the amount you owe to the party.
What is included in Accounts Payable?
- accounting services
- legal services
- marketing services
- recruiting/HR services
The Pros and Cons of Accounts Payable
The concept of accounts payable has both merits and demerits. The advantages of the concept include:
- It allows a company to operate on credit
- It aids in keeping track of all the liabilities and debts
- If the payable entry is recorded properly, it helps you in knowing exactly how much you owe to different accounts
However, there are limitations to the concept as well. This include:
- It gives isolated information. You can’t solely rely on the information provided by accounts payable to effectively manage your cash. Without other measures, like receivables and inventory processing, the information provided by account payable isn’t enough.
- It doesn’t relay any information about non-financial factors. For instance, too many account payable records might seem bad for the company. However, if you have a good relationship with your suppliers, it might not be as alarming as it seems.
Accounts Payable vs. Accounts Receivable. What’s the Difference?
Some people might get confused about whether an item belongs in accounts receivable or accounts payable. The two accounts are an exact opposite of one another. While account payable refers to the amount you owe to other parties, accounts receivable refer to outstanding payments that have to be made to the company by its customers.
For example, let’s say you allow your customers to avail your service on credit. Until they pay for the service, the amount will be recorded in accounts receivable. The treatment of account receivables in journal entry is also antithetical to accounts payable. Here, the amount is debited since account receivable is treated as an asset.