What is Accounts Payable (AP) in Finance?

Accounts Payable (AP) represents an account within a general ledger that reflects a company’s obligations to pay off a short-term loan or debt to the company’s suppliers or creditors. The term “AP” is also used in the business division or department of a company that is responsible for making payments on behalf of the company to its suppliers and creditors.

Accounts Payable (AP) Explained

The total accounts payable (AP) of a company balance at a given time will reflect on the company’s balance sheet under the current liabilities section. All accounts payable are debts that the company must pay within a given time to avoid any default or extra charges. In more familiar terms, AP in the corporate world is the same as IOU, whereby, one business collects an IOU from another business or organization. While one company records the debt in its accounts payable, the other company will add the transaction to its account receivable.

The AP plays a significant role in a company’s balance sheet. If the amount in the accounts payable increases over time, it means that the company is purchasing more goods and services on credit rather than paying cash. If the amount in a company’s accounts payable decreases over time, it means the company is settling its prior debts in due time, and not purchasing new items on credit. In managing business cash flow, accounts payable management is critical.

In preparing a cash flow statement, a company can use the indirect method, which allows the net increase or decrease from a prior period to appear in the top section.

A company’s management can also use accounts payable to control the company’s cash flow to a certain extent such that the company is able to increase cash reserves for a given period by extending the time the business takes to pay all debts in the AP. This payment flexibility depends on the type of relationship both parties share. Nonetheless, it is good business practice to pay debts when due.

How to record accounts payable (AP)

A typical double entry bookkeeping technique requires the availability of an offsetting debit and credit for all entries in the general ledger. Recording accounts payable requires that the accountant or bookkeeper credits the AP when an invoice or bill is received. The debt offset will be recorded in an expense account for the item or service that was purchased on credit. The debt could be recorded under an asset account is the good or service purchased was a capitalizable asset.

Once the debt has been paid, the accountant will debit the accounts payable by the exact amount to decrease the liability balance. The offsetting credit will be recorded under the cash account, and the cash balance will decrease.

Example;

If a business receives an invoice for $400 for items purchased on credit, the invoice will be forwarded to the AP department for documenting. The accountant in charge of the books will record a $400 credit in accounts payable and a $400 debit to expense account. The $400 debit to expense will flow through the income statement. This means that the company has recorded the purchase transaction, but is yet to make payment. When the company pays the debt, the accountant will enter a $400 credit to the cash account and a debit for $400 to accounts payable.

Accounts Payable and Trade Payables

Both ‘accounts payable’ and ‘trade payables’ can be used interchangeably, although they slightly differ in situations. Trade payables is the money a company owes its vendors for inventory-based goods such as office/business supplies or materials. While accounts payable has to do with all a company’s short-term debts or financial obligations. For example, if a restaurant purchases foodstuff from a grocery store on credit, the items are part of the restaurant’s inventory and will be treated as tradable payables.

Accounts Payable and Accounts Receivable

Accounts receivable is the direct opposite of accounts payable. In accounts payable, a company owes its suppliers or creditors money. While in accounts receivable, money is owed to a company by a receiving company. When one company transacts on credit with another, the receiving company will record the transaction in its accounts payable and the other company will record the transaction in its accounts receivable.