accounts payable asset or liability

Is Accounts Payable an Asset or Liability? A Detailed Explanation

Finding the answer to whether accounts payable is an asset or a liability is one of the most common confusions small business owners and accounting students face. This is because accounts payable seems like an asset as it represents goods or services you have received. However, accounts payable is actually a liability as you still owe money for those goods or services.

In this comprehensive guide we will clear the air on this accounts payable asset or liability question once and for all. Read on to learn

• The definition and meaning of accounts payable
• Why accounts payable is a liability, not an asset
• The journal entries for recording accounts payable
• The effect of accounts payable on the balance sheet
• Examples and illustrations of accounts payable
• Strategies for managing your accounts payable

What is Accounts Payable?

Accounts payable refers to short-term debts or obligations that a business owes to its suppliers and vendors. It represents the value of goods and services that a company has received but not yet paid for.

When a business buys goods or services on credit, it records those purchases as accounts payable liabilities on its balance sheet. Accounts payable is essentially the opposite of accounts receivable, which represents money owed to the business by its customers.

Some common examples of accounts payable include:

• Inventory purchases made on credit
• Utility bills owed
• Outstanding invoices from suppliers and vendors
• Short-term loans from financial institutions

As you can see, accounts payable represents obligations that the company must pay off within a year. This is why it is recorded under current liabilities on the balance sheet.

Why is Accounts Payable a Liability?

There are two main reasons why accounts payable is considered a liability rather than an asset:

1. There is an obligation to pay

The key characteristic of a liability is that there is an obligation to pay it off in the future. When a business purchases inventory or services on credit, it has an obligation to pay the supplier in the agreed timeframe. The business owes money, and this obligation makes accounts payable a liability.

1. No ownership of assets

With accounts payable, the business does not yet own the assets purchased on credit. Even though the inventory is physically in the company’s possession, it legally belongs to the supplier until the amount owed is paid off. Therefore, accounts payable does not represent an asset owned by the company.

In contrast, accounts receivable represents money owed to the business for assets it has sold on credit. The business retains legal ownership of inventory or services sold until the customer pays for them.

Recording Accounts Payable Journal Entries

Whenever a business purchases inventory, materials, or services on credit, the accountant records it as a liability using the following accounts payable journal entry:

Debit: Expense account (for the items purchased on credit)

Credit: Accounts Payable (liability incurred)

For example, if a business buys $5,000 of office supplies on credit from a vendor, the journal entry would be:

Debit: Office Supplies Expense $5,000
Credit: Accounts Payable $5,000

When the business eventually pays off the accounts payable balance, the accountant records it as:

Debit: Accounts Payable $5,000
Credit: Cash $5,000

The accounts payable account has a credit balance because it is a liability. The debit to accounts payable reduces the liability when payment is made.

Effect of Accounts Payable on the Balance Sheet

On the balance sheet, accounts payable is recorded as a current liability. The accounts payable balance represents short-term debts owed by the company.

An increase in accounts payable during a period indicates that a business is purchasing more goods/services on credit compared to cash purchases. A higher accounts payable balance also means that the company is taking longer to pay off its suppliers.

A decrease in accounts payable signifies that the business is paying off obligations faster. The company may be better managing its working capital, taking advantage of early payment discounts, or simply making fewer credit purchases.

As a current liability, accounts payable also impacts a company’s working capital position. Working capital represents current assets minus current liabilities. A high accounts payable balance reduces working capital available to the business.

Examples of Accounts Payable

Let’s go through some examples to reinforce the accounts payable concept:

Example 1:

Jen’s Bakery purchases $3,000 of baking supplies on 30-day credit terms from XYZ Supplies.

When the supplies are received, Jen’s Bakery would record the following journal entry:

Debit: Supplies Expense $3,000
Credit: Accounts Payable $3,000

This increases expenses and liabilities by $3,000 each.

Example 2:

Peter’s Plumbing completes some emergency repair work for $2,500 at ABC Company’s premises. ABC Company is given 15-day credit terms on the invoice.

ABC Company would make this journal entry on receiving the invoice from Peter’s Plumbing:

Debit: Repairs & Maintenance Expense $2,500
Credit: Accounts Payable $2,500

This records the increase in ABC Company’s accounts payable liability.

Example 3:

Jerry’s Jewelers purchases $7,000 of jewelry inventory on credit from a supplier. The payment term is 2/10, net 30 – a 2% discount if paid within 10 days, else full payment due within 30 days.

On receipt of goods:

Debit: Inventory $7,000
Credit: Accounts Payable $7,000

If paid within 10 days:

Debit: Accounts Payable $7,000
Debit: Cash Discount Expense $140 (2% of $7,000)
Credit: Cash $6,860

The accounts payable balance reduces by $7,000 while cash is decreased by the discounted amount paid.

Strategies for Managing Accounts Payable

Here are some tips for businesses to better manage their accounts payable:

• Maintain a schedule of payment due dates so you don’t miss any deadlines

• Take advantage of early payment discounts offered by suppliers to reduce costs

• Avoid excessive credit purchases that can inflate accounts payable and reduce working capital

• Keep accounts payable balance low to increase short-term liquidity

• Check supplier statements for any discrepancies with your own accounts payable records

• Pay small suppliers quickly to maintain good relationships and credit terms

• Get inventory and materials insured so risk shifts to insurer if unpaid

• Consider using supply chain financing or reverse factoring to extend accounts payable

The Bottom Line

While it may seem counterintuitive at first, accounts payable represents a liability, not an asset, for a business. This is because accounts payable refers to goods/services received but not yet paid for. The company incurs an obligation to pay suppliers, distinguishing accounts payable as a liability.

Proper recording and management of accounts payable are critical for maintaining positive supplier relationships and healthy working capital levels. Businesses can optimize their accounts payable process to unlock savings and minimize financial risks.

So the next time you come across accounts payable in a balance sheet, keep this in mind – it is definitely a liability! With the knowledge from this guide, you can now decipher the accounts payable asset or liability dilemma confidently.