Accounts payables and accrued expenses are similar short-term obligations of a business. While both represent short-term liabilities of a business, they differ in nature and accounting treatment for a business.
Let us discuss what are the key differences between accounts payable and accrued expenses for a business.
Accounts Payable – Definition
Accounts payable (AP) or simply payables refer to the short-term debt of a company against purchases or services received on credit.
It is the total amount payable by an entity to its suppliers, vendors, and trade partners. It is often accumulated against raw material or inventory purchases.
Accounts payable represent a liability of a business for purchases and services received before paying. However, these payables do not include any cash transactions.
Accounts payable is a current liability as the creditors often allow credit terms up to one year only. In practice, the accounts payable terms are around 90 or 120 days.
Accounts payable can include any type of business payment for which a business has received goods or services but has not paid yet.
Accrued Expenses – Definition
An accrued expense is a liability of a business that becomes liable due to past events and is due in the future.
Accrued expenses are accumulated over time and recorded at the end of the accounting period. For instance, a business can record accrued expenses for a month or a quarter.
Accrued expenses occur when a business purchases goods or receives services but the counterparty does not issue an invoice.
In simple words, accrued expenses are confirmed liability of a business at a future date but without formal billing or invoicing from the customer.
Since a business is certain about paying an expense, it must record a liability in its account books. Therefore, a business would accumulate all accrued expenses for an accounting period and record the total as a short-term liability in its balance sheet.
How Does Accounts Payable Work?
Accounts payable are all purchases, contract payments, or services received on credit terms.
The payment date, amount, and method are known to a business for its payables. It means AP represents a certain liability that a business can identify and is payable at a certain future date.
A business will record a short-term debt or liability when it receives an invoice. Usually, the creditors allow a 90- or 120- days AP term. The longer an AP term the better it is for a business.
Accounts payable may witness an increase or decrease from previous periods. When a company purchases on cash or makes a previous payment, its AP balance reduces. Contrarily, its AP balance increases when it further purchases goods on credit terms.
A business with good AP management can ease the cash flow for its working capital. Accounts payable works as a short-term credit facility for a business without paying interest.
A business should carefully manage its AP since creditors would closely monitor its AP balance on the balance sheet and analyze key payables ratios to evaluate the financial health of a business.
How Do Accrued Expenses Work?
Contrary to accounts payable, accrued expenses are certain in payment but uncertain for date and even amounts sometimes.
Simply, accrued expenses become liability for the fact that a business has incurred an expense. However, since the counterparty hasn’t issued an invoice yet, it does not become an obligation with certainty.
Also, accrued expenses are often compiled for an accounting period. A business would record all of its accrued expenses for a month or a quarter under the short-term liability section of its balance.
Accrued expenses are used by businesses with accrual accounting. It means a business would record accrued expenses when they are incurred.
Contrarily, a cash business will record an expense when it is paid.
Accrued expenses are often recurring in nature. A business would record an initial liability against these expenses and make payments at their due date in the future.
Often a business may not record accurate amount for accrued expenses. It may then record an adjusting or revised entry or record a new short-term liability to accurately represent its account books.
Suppose a company ABC purchases inventory from a supplier XYZ on credit terms. The total purchases amount to $ 100,000. ABC company makes an advance payment of $25,000 and the remaining balance on credit terms of 120 days.
ABC Company will record accounts payable of $75,000 in its account books initially. If the company pays $75,000 on its due date in full, it will record a reversal entry to remove accounts payable from its record.
Suppose ABC Company has accumulated staff salaries of $ 300,000 for the month of June. ABC Company will record an accrued expense of staff salaries on the first day of the month as the salary will be payable to its staff in 30 days.
Common examples of accrued expenses include:
- Salaries and wages
- Interest payment
- Accrued tax payments
- Recurring contract payments
Journal Entries for Accounts Payable
Continuing with our example above, ABC Company will recognize a short-term liability of $ 75,000 for its accounts payable.
At the time of recording AP, the journal entry will be:
|Inventory Purchases||$ 75,000|
|Accounts Payable||$ 75,000|
At the time of payment, the journal entry will be:
|Accounts Payable||$ 75,000|
The company can record partial accounts payable entries using the same journal format as well.
Journal Entries for Accrued Expenses
Continuing with our example above, ABC Company can record a journal for its accrued expense of salaries for the month of June and then reverse the entry when its pays salaries to the staff.
The initial journal entry to record accrued expense will be:
|Salaries Account||$ 300,000|
|Accrued Expense||$ 300,000|
ABC Company will record the reversal entry for the accrued expense of staff salaries with the following journal entry:
|Accrued Expense||$ 300,000|
Similarly, a business can record partial payments of accrued expenses for different accounts.
Accounts Payable Vs Accrued Expenses – Key Differences
Both are short-term liabilities of a business. Payables are more certain and can be recorded accurately in terms of amount, payment terms, and payment date.
Contrarily, accrued expenses are accrued over time and are often uncertain for amount, payment date, and do not come with credit terms.
A business would often incur payables as well as accrued expenses. The impact of both types of liability will have some key differences for the business.
Differences by Definitions
Accounts payable is a short-term liability of a business that a business incurs when receiving an invoice or bill for purchases of goods or services on credit terms.
Contrarily, accrued expenses occur due to past purchases of goods or services that are payable at a future date. These expenses are accrued when a business does not receive an invoice or bill.
Payables are certain for the amount and payment dates. Creditors often allow a specific window to pay credit amounts without incurring any interest charges.
Accrued expenses are also confirmed liabilities. However, the counterparty does not issue an invoice and the payable amounts are often varying.
Both accounts payable and accrued expenses are recorded on the balance sheet of a company under the short-term liabilities section.
If a company incurs (accrues) a significant accrued expense amount during an accounting period, it can record the amount on its income statement as well.
Managing payables and accruals are an important part of the short-term liquidity requirement of a business.
Both are short-term liabilities and delaying both means utilizing the available cash. However, a prolonged delay can cause a negative impact on supplier relationships for a business.
Pros and Cons for the Business
Accounts payable work as a short-term credit facility for a business. Suppliers extend credit terms without incurring interest charges.
However, a default on payables means compromised supplier relationships and facing legal implications.
Similarly, accrued expenses are certain liabilities. A business can only delay cash payments up to a certain limit. For instance, delaying accrued taxes will not only incur penalties but may result in significant legal complications for a business.
Here are a few other miscellaneous but key differences between accounts payable and accrued expenses.
- Payables represent the accurate and confirmed short-term liability of a business with an invoice received.
- Accruals may change due to a change in the rate of the service and hence can be uncertain.
- Accruals are recorded at the end of the accounting period whereas payables are recorded as and when invoiced.
- Accrued expenses are often period and recurring. While payables can also be recurring, they are often trade-related and non-periodic.
- Payables are due towards suppliers and vendors whereas accrued expenses are due towards banks, government entities, employees, and creditors of a business.