Accounts Payable (AP)
Accounts Payable, or AP in its abbreviated form, is a ledger entry made for amounts owed to creditors in the short-term, typically less than a year, on an open account. It is generally recorded as a collection of invoices and promissory notes received from a vendor. Each invoice has different credit terms and payment amounts that are specific to the vendor. Typically, the sum of all A/P entries represents liabilities owed by a company at a specific point in time. An accounts payable entry for an accounts payable department in an organization is an accounts receivable entry for its supplier.
Accounts payable can also be used to refer to a department responsible for handling tasks or duties related to AP entries. In addition to recording invoices and contracts, an accounts payable department is responsible for recording expenses incurred during the company’s internal operations.
What Is Accounts Payable?
In the double-entry accounting system, accounts payable is one side of a ledger entry. Accounts receivable is the other. At any given point of time, accounts payable is a snapshot of the amount that the company owes its creditors.
Typically, a company purchases goods on credit and receives periodic invoices from vendors for the goods. The invoices are specific to payment terms. For example, the company may be required to pay off a vendor in 60 days while the timeline of payment to another vendor may be 90 days. These invoices are recorded as accounts payable in the company’s accounting system. The vendor’s accounting system records the same entries as an accounting receivable because the vendor expects payment from the company within that timeframe.
In addition to vendors, the company also incurs other expenses in the form of business expenses. For example, it will need to reimburse employees for expenses, when they travel. It will also need to pay out reimbursement claims for office expenses, such as stationary, and invoices for maintenance of facilities from contractors. These are all recorded under Accounts Payable.
While they are liabilities, employee salaries are not considered accounts payable and are recorded under a separate heading for payroll. This is mainly because they represent liabilities that the company owes to employees and, also, accounts receivables at the same time because it is owed tax withholdings from the government.
Small outfits generally have multi-tasking accounting divisions in which a single team handles both accounts receivables and accounts payables. As the company grows, however, the number of accounts payable entries that its accounting team must handle multiplies. That is why, in large organizations, there are separate teams to handle accounts payables and receivables.
Making an Accounting Payable Entry
As explained earlier, not all the money owed by a company to creditors is eligible for AP entry. Typically, an AP clerk will need to thoroughly check all invoices, purchase orders, and contracts issued by the company to identify AP entries.
Under the accrual method of accounting, an invoice or purchase order is recorded when it is presented by the creditor (as opposed to when it is paid). A vendor’s invoice is considered a credit entry under AP. Because accounting books must be balanced on both sides of the ledger, the accounting entry is also recorded as a corresponding debit to another account. For example, consider the case of an air ticket invoice for business travel sold to a company that makes widgets. The ticket is entered as a credit in the AP ledger because the ticket amount will be paid to an external ticketing agent and as a debit under the travel expenses ledger.
When the invoice is actually paid out, the corresponding amount from AP will be debited and the cash account will be credited. This process is repeated for all invoices, purchase orders, and expenses received by an organization. Thus, an accounts payable account should display a company’s liabilities at any given point of time.
An alternative to accounts payable is the cash accounting method in which companies record invoices or purchase orders only when they make a payment. This method is generally used by small companies and inflates expenses when payments are made. It can also cause problems during the closing process.
Accounts Payables Across Industries
Accounts payables can be an important metric to analyze in a company’s financial statements because it can be an indicator of total debt and liabilities for the organization. Depending on the sector, the accounts payable figure can vary across industries. For example, companies that manufacture their final products typically tend to have high amounts of accounts payable and take the longest to get paid.
According to a 2011 analysis conducted by Sageworks, 12 of the top 20 industries with longest accounts payable times were in manufacturing. Those high figures are a function of the industry’s processes and the geographic breadth of the modern supply chain. Thanks to vast improvements in transportation and technology, most manufacturers source their raw materials from geographies that are distant from their headquarters.
An example is technology behemoth Apple Inc. which is headquartered in California but has a factory in China that sources raw materials from all over the world. After being manufactured, the finished product must be shipped to multiple markets all over the world. Each jurisdiction has its own set of regulations concerning imports. A result of this is that finished goods can spend a considerable amount of time stuck in customs. All of this adds up to considerable accounts payable balances. Retail is another sector that tends to have high accounts payables figures for many of the same reasons described above.
The construction and real estate industry, however, needs a robust cash flow to finance its operations. It cannot afford to keep idle inventory on its hands because those unfinished materials or buildings translate to potential losses and taxes. Hence, the industry enforces quick payment rules to ensure quick turnover in making a building. Many services firms in the tech sector also have low figures for accounts payable mainly because they do not have to expend cash on purchasing raw materials or transporting finished goods across borders. They also have efficient and automated processes that minimize inventory and lead to higher profit margins.
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About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.