Accounts Payable - AP
an account representing a company's short-term debts as the result of purchasing goods or services in credit.
Accounts Payable Details
As a short-term liability, corporations will typically pay off accounts payable (AP) in less than 12 months. If companies fail to pay the debt in time, they may fall into debt and default. Throughout a fiscal period, the AP exists within the general ledger of a company. At the end of the period when the company releases its financial statements, the AP total appears under current liabilities.
How a company treats AP affects the company's cash flow. Companies generally pay current debts by the time they're due. But they may also request a time extension so that they can reserve more cash if needed. That said, companies need to demonstrate good faith to their vendors, so repeatedly extending outstanding loans is not a wise move.
Accounts Payable Example
Let's say that a business purchases $4,000 worth of computer peripheral in credit. The business adopts double-entry bookkeeping with an accrual accounting method. This method recognizes transactions before any cash exchange happens. In that case, once the company receives the bill for the equipment, the bookkeeper will record the transaction on the general ledger with these entries: a $4,000 debit to assets account and a $4,000 credit to accounts payable.
Moving on to the next period, the due date for the machinery is approaching. Seeing this, the company plans to pay the full price of the equipment in full. After the company pays the bill, it will once again record the transaction as a $4,000 debit to accounts payable and a $4,000 credit to cash.
If any outstanding loans from accounts payable remain at the end of the current period, the account will appear on the balance sheet. Accounts payable on the balance sheet represents the total amount of unpaid goods or services with short-term due dates, which may source from multiple suppliers.
Significance of Accounts Payable
Apart from telling a company how much short-term debt it owes, accounts payable can be a useful indicator for analysis purposes. For instance, companies can compare the amount of AP during the current and the previous period. AP increase means that the company is purchasing more goods or services on credit, while AP decrease shows that the company manages to lower the amount of outstanding debt over time. This type of analysis can help the company plan for the future.
Investors and analysts may also use accounts payable to determine the liquidity of a company. For example, accounts payable is the main ingredient to calculate the accounts payable turnover ratio, which determines the pay-off rate of a company. In other words, it can show how efficient a business is at settling its short-term debts.
Accounts Payable vs. Accounts Receivable
Accounts payable and accounts receivable are mirror images of each other. It just depends on whether a company is a borrower or a lender. Accounts receivable is the account indicating the amount of money customers haven't paid for delivered goods or services.
If a business buys goods from another company in credit, it will record the transaction as accounts payable on the ledger. On the contrary, the lender company that sells the goods on credit will post it as accounts receivable with the same amount.