Is accounts payable an asset or liability? When companies make purchases, they either pay in cash immediately or receive the goods and services on credit. When the latter happens, the goods or services received will be recorded differently than that of a cash purchase. The money owed to suppliers or service providers is recorded as accounts payable. Accounts payable usually have payment terms associated with them and are recorded on the company’s balance sheet.
Understanding whether accounts payable is an asset or liability is pertinent to all business owners, furthermore, making the right accounting entry for the accounts payable is important so as to have accurate financial records and also manage cash flow efficiently. Here, we will discuss what accounts payable means and how it is recorded. We shall also discuss assets and liabilities in order to know whether the accounts payable are an asset or a liability.
Accounts payable, assets, and liabilities explained
Since our focus here is to understand whether accounts payable is an asset or liability, we first have to understand what accounts payable, assets, and liabilities each mean.
What are accounts payable?
Accounts payable refer to the credit obligations of companies for goods or services received which have not yet been paid for. It is considered a short-term debt owed to creditors and suppliers and is commonly abbreviated as AP.
When companies receive goods or services on credit, the payment for these goods or services received must usually be made between 30 to 90 days; this is dependent on the payment terms associated with the goods or services. If the company is unable to complete the payment within the stipulated time frame, that particular payable is said to be in default.
When the balance of the accounts payable account increases from one accounting period to the next, it indicates that the company buys most of its products and services on credit whereas when the accounts payable account decreases from one accounting period to the next, it indicates that the company is repaying its debt efficiently and is either not buying more goods and services on credit or the company takes a longer interval between payments and new purchases on credit.
Having a low accounts payable balance increases the credit ratings of companies because it indicates that they do not owe large amounts to suppliers and creditors and that they pay their debt efficiently. Additionally, settling outstanding accounts payable at their latest authorized date temporarily increases the company’s cash reserves until the repayments are made. The only disadvantage of this delayed payment of the accounts payable is that the company might not enjoy any sales discount associated with the goods they had purchased on credit since most discounts typically apply to early payments.
One important metric used by financial analysts, creditors, auditors, and accountants to calculate a company’s liquidity is the accounts payable (AP) days. The accounts payable days are the average number of days companies take to pay off their accounts payable balance. Additionally, financial analysts, creditors, and auditors use the accounts payable turnover (APT) to evaluate a company’s ability to pay off its creditors, suppliers, and service providers and how frequently they are able to do so within each accounting period.
Recording accounts payable
When companies purchase goods or services on account, there has to be an accounting entry in their financial books to record the transaction. The journal entry is done to keep track of the debt as well as show that the company owes that amount to a supplier or service provider. The accounts payable journal entry indicates that there are suppliers or service providers that have a claim on the company’s assets.
Making a journal entry for accounts payable involves a credit to the accounts payable account and a debit to the expense or asset account; depending on whether what the company purchased is considered an expense or an asset. Expenses are costs that companies incur for their daily business operations.
For example, if TotalEnergies buys supplies of $200,890 on the account. It means that they owe their supplier $200,890. In order to record this transaction, it will involve a debit to an expense account (supplies) and a credit to the accounts payable account as shown in the table below:
Similarly, if the company buys assets such as computers to aid its employees’ efficiency, it will record the purchase in a similar way as the table above with a debit to the asset account and a credit to the accounts payable account.
What are assets?
Any item owned by a company that has economic value is considered an asset. Assets generally improve the company’s productivity and sales, generate revenue, and reduce the expenses incurred by the company. A company’s balance sheet lists the different assets of the company whether they are tangible, financial, intangible, fixed, or current assets.
Tangible assets include all the company’s assets that can be seen physically such as real estate. Financial assets are investments the company has made in other companies such as bonds and other securities. Intangible assets include goodwill, patents, copyright, and all other non-physical assets of the company. Fixed assets are assets that require more than one fiscal year to be converted into cash, they include equipment, property, etc. Current assets include cash and cash equivalents, accounts receivable, inventory, marketable securities, and all other assets that can be readily converted to cash within a fiscal year.
The balance sheet of a company is built on the accounting equation where assets are equal to the sum of the liabilities and equity of a company; this is expressed as Assets = Liabilities + Equity. This means that in order for the company’s balance sheet to be balanced and accurate, its assets must not exceed the sum of its liabilities and equity; in the same vein, the sum of its liabilities and equity must not exceed its assets.
Assets are generally financed by debt, which is considered liabilities or by shareholders’ equity. Assets are simply all resources that the company owns and all that is owed to them.
What are liabilities?
Liabilities are all that the company owes to creditors as a result of transactions that were carried out on account. When transactions are carried out on the account, it means they were not paid for when the transaction occurred, hence they were taken on credit. Liabilities also include payments received by the company in advance for goods or services that have not yet been received by the client.
Liabilities are therefore claims that creditors have on the company’s assets and are commonly classified as either short-term or long-term liabilities. Current liabilities have to be settled within one year while long-term liabilities take longer than a year to be settled.
Liabilities include rents and utilities, dividends payable, accounts payable, taxes payable, accrued expenses, unearned revenue, interest payable, notes payable, and salaries. Liabilities are recorded on the balance sheet of companies along with assets and equity.
Is accounts payable an asset or liability?
Accounts payable is an account on the company’s balance sheet which records all that the company owes to service providers or suppliers. They usually have to be paid within 30 – 90 days, hence they are considered short-term liabilities and are recorded in the liabilities section of the balance sheet. Therefore, accounts payable is not an asset, it is rather a liability.
Although both the accounts payable and the accounts receivable have payment terms associated with them, the accounts payable should not be confused with the accounts receivable. The accounts receivable records all the monies owed to the company for goods or services it has offered to customers on credit. While the accounts payable is a liability because it is money the company owes to service providers and suppliers, the accounts receivable is an asset because it is money that customers owe the company for the goods or services they received from the company on credit.
Accounts payable is a current or short-term liability since it generally has to be settled within 90 days. Accounts payable is listed under the current or short-term liabilities section of the company’s balance sheet.
See also: Balance sheet substantiation
Accounts payable is not an asset, it is a current liability that must be settled within 90 days. Accounts payable are obligations that a company has incurred that are yet to be settled and are listed on its balance sheet as a current liability since they have to be settled in the short term. Examples of accounts payable include contractor fees, unearned service revenue, supplier invoices, legal fees, etc.
Maintaining the accuracy and timeliness of the accounts payable aids companies in better understanding their liabilities. It further affects their cash flow, attractiveness to investors, credit rating, borrowing costs, and financial health. The accounts payable is also useful to business analysts, auditors, and creditors as it provides them with the bedrock of understanding how prompt a company is when it comes to the repayment of its short-term liabilities.