When a company commences its operations, it incurs a variety of expenses too. However, regardless of the expenses being recognized in the books, the company does not always pay cash at the time the expense occurs.
Hence, it becomes a legal obligation for the company to clear its dues which are also referred to as liabilities.
Accounts Payable and Notes Payable are both liabilities by nature; however, the processes of occurrence of both are quite different.
Accounts payable are short-term liabilities that are usually settled within 30 days of occurring. Businesses record accounts payable in their books when they purchase goods or materials from their vendors on a credit basis instead of a cash basis.
Notes payable are written promissory notes that are issued by financial institutions or banks when a company borrows money from them.
In other words, notes payable is a written promise by the company to return the amount owed over a certain period along with interest.
The principal amount, interest payable, and the due date are all specified on the promissory note.
Financial Reporting of Accounts Payable and Notes Payable:
Accounts Payable and Notes Payable are both reported as liabilities of a company on the balance sheet.
The balance sheet portrays the financial position of a company; hence, it incorporates separate sections for both long-term and short-term future outflows of cash.
For purchasing of goods or materials, a company usually issues a purchase order to the vendor.
The supplier, in turn, sends the goods and a sales invoice which specifies the quantity of goods, the amount owed, and by what time should it be settled.
Since purchasing of goods is a part of daily operations and needs to be done quite frequently, accounts payable are paid off within days or a couple of months (if facing liquidity problems).
Hence, accounts payable is reported under the current liabilities section of the balance sheet.
On the other hand, notes payable are usually long-term liabilities and are reported under the non-current liabilities section of the balance sheet.
However, notes payable can also be classified as a current liability in case it is due within one year.
Promissory notes are written agreements between companies and financial institutions issued when companies borrow money to make investments for business growth.
For example, purchase of plant and machinery.
Key differences between Accounts Payable and Notes Payable:
- Accounts payable is a liability owed to suppliers and vendors whereas notes payable is a liability due to banks and financial institutions.
- Accounts payable is recorded when credit purchase of tradable items is made whereas notes payable may originate for purchase of non-current assets.
- Accounts payable can always be converted to notes payable if the vendor issues a promissory note to the company whereas notes payable can never be converted to accounts payable.
- Accounts payable occur when the vendor/lender believes the receiving company is creditworthy and low-risk whereas notes payable is issued to ensure high-risk customers are legally obligated to pay back.
- Accounts payable can be paid off whenever whereas notes payable are to be cleared over a period of a specific time.