Unlike the cash basis of accounting, an accrual-based accounting system signifies recording all the transactions, either credit or cash, to be recorded in the financial statements of a business entity. Accrual accounting is a widely used accounting system across small businesses, large corporations, or even multinationals.
On the other hand, cash accounting emphasizes only recording the events that involve cash receipt or payment. However, the accuracy of the financial statements and records is hurt in this way. Therefore, accrual accounting is preferred over cash accounting.
Under the accrual accounting, the credit purchases of the company are recorded as an account payable in the balance sheet. The accrued expenses are also the company’s liability recorded in the balance sheet and income statement.
This article will dissect the account payable and accrued expenses. What is the main difference between the two? Let’s find out.
Account payable is a balance sheet item. It represents the amount due on a business entity for the credit purchases or services already taken but yet to be paid.
More comprehensively, we can define accounts payable as,
Account payable is an account of a general ledger. It reflects the short-term debt of a business entity towards the suppliers and creditors. Accounts payable or AP is recorded in the general ledger. The item is shifted to the current liabilities in the balance sheet.
Account payables are specified as current liabilities in the balance sheet of a business entity. It is an important item in the company’s general ledger as well as a balance sheet. When a company purchases material on credit, the account payable will be credited with the name of the supplier or creditor. So, account payable is a consolidation of all outstanding accounts of creditors and suppliers.
Explaining Account Payable
Since accounts payable are the future cash payment, it also plays a role in cash management. For instance, the net increase or decrease in the business’s accounts payable is recorded in the cash flow statement in the cash flow from operating activities.
If we talk about recording accounts payable in the books of accounts, they’re a balance sheet item. However, the creation of accounts payable corresponds to a transaction of a business entity. The accounts payable, the short-term debt of a business, are recorded under the double-entry system that requires an equal amount of debit and credit in every transaction.
In the case of accounts payable, the credit purchase gives rise to the AP. Therefore, the purchase of inventory or raw material increases one asset of the company and debited. On the other hand, credit purchase increases the liability of the company. Therefore, an equal amount is a credit in the name of the supplier or collective accounts payable. When the credit purchase corresponds to a company’s capital asset, the debit amount will be for that particular ‘asset account.’
When the due date arrives, the company pays the creditor with cash or cheque. It will decrease the cash or bank balance of the company. Since both are company assets, the decrease in the asset will be credited for either case.
On the other hand, offsetting the account payable will show a decrease in liabilities of the company that is a debit. The journal entry will be account payable debit and cash or bank credit. Any cash discount for early payment will also be credited, and the remaining amount will be credited from cash.
Let’s take an example.
Company ABC had purchased inventory from Samuel & Co.(supplier) on credit amounting to $1000. The amount was due in 3 months. The journal entry for the credit purchase was as follow:
|Samuel & Co Account/Account Payable||$1,000|
After three months, the cash was paid to Samuel & Co in settlement of his account. The books of account recorded the transaction as a journal entry,
|Samuel & Co Account/Account Payable||$1,000|
Accrued expenses of a business entity are also a current liability and are recorded in the balance sheet. These are the expenses of a company, services for which have been taken, but the receipt of services or documentation proof has not been generated.
Accrued expenses can be formally defined as,
Accrued expenditures of a business entity are the costs that have been incurred during the current financial period, yet they have not been paid.
Accrued expenses of a company that have already happened, but their documented proof has not been generated yet. Accrued expenses have derived the name from accrual accounting. Therefore, they are recorded when services are taken and not when the accounts are settled.
The accrued expenses are classified as a short-term liability of the company and recorded in the balance sheet under current liabilities. Although it is a short-term liability, it differs from the accounts payable. Accrued expenses of a business entity are estimates. The actual expenses might be more or less than the actual invoice in the future.
Characteristics of the accrual system apply to the accrued system for their recognition and recording in the books of accounts. The recording of accrued expenses in journals and ledgers is more complicated than the other expenses. Therefore, the business entities mostly accrue an expense only if it is substantial.
It is generally thought that account payables and accrued expenses differ as to the account payables for credit purchases. However, the difference between the two is that the accrued expenses are those outstanding expenses yet to be invoiced. However, the account payable is those expenses that have been invoiced. Therefore, any credit purchase that has not been invoiced by the supplier yet also becomes part of the company’s accrued expenses.
The accrued expenses are also opposite to prepaid expenses. Prepaid expenses are the company’s asset that arises due to advance payment of probable expenses in the future. On the other hand, accrued expenses arise due to receiving services or product even before it is invoiced.
The most common examples of accrued expenses are wages, accrued interest payable, utility expenses, employees’ salaries, inventories, and supplies on credit.
Let’s understand the concept with an example.
John & Co. usually pays salaries to the employees on the second or third day of the following month for services provided in the previous month. The company prepared the accounts for the year ending the 31st of December on the last day of December. The salaries for December were not invoiced yet. Therefore, the employees’ salaries become an accrued expense of the company.
The following journal entry will be passed in the books of accounts:
|Accrued Liability Account||xxx|
As the 2nd of January approached, the company paid the employees’ salaries and invoiced them. The journal entry was made as follow:
|Accrued Liability Account||xxx|
|Cash/ Bank account||xxx|
Key Difference Between Account Payable And Accrued Expenses
From the dissection of accounts payable and accrued expenses, we can already differentiate the two. However, some acute factors differentiate accounts payable from the accrued expenses.
The first difference is between the nature of accrued expenses and account payables. Both are recorded in the current liabilities of the balance sheet; however, they differ from each other. The accounts payable are the absolute and actual liability of the business entity. It has already been invoiced and will be paid in the future for the same amount as the invoice.
On the other hand, accrued expenses of a business entity are estimated amounts. The company records accrued expenses to make an estimate of cash outflow in the future.
Entry In Financial Statements
Accrued expenses as well accounts payable are shown on the balance sheet under the current liabilities. However, the accrued expenses are not only recorded in the balance sheet. The income statement also has a record of accrued expenses.
The account payable is recognized in financial records after the invoice has been generated and received by the business entity. However, the accrued expenses are recorded in financial statements before generating invoices from the supplier or the creditor.
Furthermore, recognition of account payable is a regular affair for a business entity. However, accrued expenses are not regularly recorded.
Examples of account payable are credit purchases of inventory, supplies, or raw material. Examples of accrued expenses are interest accrued on debt, salaries, wages payable, etc.
We’ve differentiated the account payable and accrued expenses from the perspective of accounting recognition. Despite both being current liability for a business entity, they differ in recognition, nature, and classification. Both account payable and accrued expenses are based on an accrual accounting system; the business entities must comply with the GAAP or IFRS for recording the transactions.