Accounts payable appear on the balance sheet and income statement of a company. However, it does not appear on the income statement of a business.
Although accounts payable is not directly recorded on the income statement, it does affect the income of a company.
Let us discuss what are accounts payable and how do they impact the income statement of a business.
What is Accounts Payable?
Accounts payable (AP) refers to the cumulative liability of a business towards its suppliers and creditors.
Accounts payable is a short-term liability that incurs when a business makes purchases on credit. Several types of liabilities can be included under the accounts payable section; however, it includes inventory purchases, transportation, logistics, and other short-term trade obligations.
Accounts payable is recorded on the general ledger book separately. Since it represents a significant liability, a business must record AP separately from other liability accounts.
It is pertinent to mention that when a business makes purchases on cash, the resulting transaction should not be recorded under the accounts payable section.
Is Accounts Payable Included in the Income Statement?
Accounts payable does not appear on the income statement of a company. It is a liability account and it appears on the balance sheet under the current liabilities section. The income statement is the summary of the revenue and expense accounts of a business. It includes all income and loss accounts generated by a business. Therefore, it does not include a liability account like accounts payable.
The accounts payable account affects the income statement indirectly. Since the AP of a business can have a positive or negative impact on the company profits, it can indirectly impact the income statement entries.
Also, the accounts payable has a direct impact on the cash balance of a company. Therefore, a change in the AP accounts will directly produce a change in the cash flow statement.
In short, the accounts payable does not appear on the income statement. Although AP can affect the balance sheet and the statement of cash flow of a business directly, it has no direct relationship with the income statement.
Liability Accounts Vs. Expense Account
Let us elaborate a bit more details on why the accounts payable accounts appears on the balance and why it doesn’t appear on the income statement.
The basic way to find where an account appears is to distinguish whether it is a liability or an expense account.
A liability is a past event that has not been paid yet. Sometimes, liability is partially paid for initially and settled in the future.
On the other hand, an expense is an obligation that has already been paid or settled. The main difference is that an expense is incurred to generate revenue.
Generally, expenses are incurred in the current account period to support the operational activities of a business. When a business fails to pay its expenses, they become the liability of the business.
Expenses are generally recurring in nature and often repeated over several accounting periods. Liabilities can also be recurring but are often one-time large transactions that generate a future obligation for a business.
Evaluating the accounts payable account on the above criteria, we can determine that an AP account is a liability and not an expense. Therefore, it would appear on the balance sheet rather than on the income statement.
Is Accounts Payable an Accrual Expense?
Accounts payable is one of many types of accrual expenses. It means every account payable transaction is also an accrued expense. An accrual expense is an expense that has been incurred due to a transaction for purchasing goods or services but has not been paid yet.
Other common examples of accrued expenses may include taxes, interest payments, goodwill, and accounts receivable.
The accounts payable is recorded as a future obligation for a business rather than an expense since it generally fulfills the definition of a liability rather than an expense.
Where Is Accounts Payable Recorded on the Balance Sheet?
As we mentioned above, accounts payable is a liability account. Then, liabilities are categorized into current and long-term liabilities.
Since accounts payable is a short-term obligation of a business that is payable from 30 to 120 days usually, it is categorized as a current liability account. Therefore, the AP account appears under the current liabilities section of the balance sheet of a company.
Some unpaid expenses that a business fails to pay on time may also be recorded as current liabilities. These expenses would also be recorded under the accounts payable section of the balance sheet.
Accounts Payable and the Cash Flow Statement
The accounts payable is recorded as a separate line item on the cash flow statement as well. The CSF has three broad categories operating, investing, and financing.
The accounts payable account is recorded as an operating activity in the cash flow statement of the business.
Although the AP balance does not appear directly on the income statement, it may have an impact on it (discussed in detail below).
Accounts payable does not affect the CFS until the account is settled. When a business makes a payment to one of its suppliers or creditors, it reduces the cash balance. Therefore, it will record a decrease in the cash on the CSF.
How Does Accounts Payable Affect Income Statement?
As mentioned above, the accounts payable do not directly affect the income statement. It does not appear on the income statement but the balance sheet and the cash flow statement. When a business records a transaction with an AP account, the contra entry is an expense account. Therefore, every accounts payable transaction will impact the income statement indirectly.
The general journal entry for an accounts payable transaction is:
|Expense Accounts (inventory, supplies, etc.)||$ XXXX|
|Accounts Payable||$ XXXX|
So, whenever a business purchases on credit, it would debit the expense account and credit the AP account. It means the gross income of the business will decrease with every credit transaction.
Since the company would have already recorded the transaction, it will have no effects on the income when the business would settle the AP account in the future.
Therefore, the AP account only affects the income statement at the time of recording the liability (and expense) and it has no impact when it is settled.
In short, when a business records an accounts payable transaction, it reduces the income. Contrarily, if there is a reversal entry or return for purchases, the business records an increase in income.
Impact of Accounts Payable for the Business
Accounts payable has direct impacts on the performance of a business in different ways.
A successful accounts payable team would arrange effective supplier relationships. It means the AP team will arrange favorable accounts payable period without affecting the pricing of purchases for the company.
Good relations with suppliers will not only bring discounts but also extend the payable period. The payment period will enable the company to utilize the cash in hand for other activities. Thus, it becomes a cheaper financing source without paying interest.
Managing accounts payable will help a business manage cash flow. It affects the short-term liquidity of a business. Eventually, if a business does not maintain good liquidity, it will turn to expensive short-term financing that will impact the profitability of the business.
Also, managing accounts payable would affect the supplier relations as it can impact the prices and payable period duration.