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Difference Between Accrued Expense and Accounts Payable
The difference between accrued expense and accounts payable are crucial. Find out about them and their value in managing your business spending.
However, the accounting world is precise, and most business owners often find themselves at a loss when dealing with all the terms that come up. As a business owner, your focus is on core tasks that will help you grow your company, not crunching numbers like a Certified Public Accountant (CPA).
Unfortunately, bookkeeping and accounting are critical tasks you can neither ignore nor delay. You need to resign yourself to knowing some accounting principles, at least when it comes to your balance sheet.
A balance sheet is a financial statement on the assets, liabilities, and shareholder equity. When it comes to liabilities, you will encounter two types of accounts under the accrual method of accounting: accrued expenses and accounts payable. On the face of it, they might seem like the same thing: money owed and paid. However, they are not the same thing.
The accrual method of accounting is much more complicated than cash basis accounting, but it is also more accurate. Knowing the difference is essential to making a transparent and actionable balance sheet. Find out the difference between accrued expenses and accounts payable.
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What are accrued expenses?
Accrued expenses, sometimes referred to as accrued liabilities, are future payments of a company for goods or services it has already received but not invoiced. The opposite is prepaid expenses, which are goods and services that the company has paid for but has not yet received. Prepaid expenses are assets, not liabilities.
Typically, accrued expenses are recurring–rentals, wages, loan payments, and utilities. At the end of the accounting period, these expenses are recognised on the balance sheet and adjusted accordingly for goods and services received but not yet invoiced. They also go in as a journal entry in the general ledger.
An example of accrued expenses may be utilities used but not yet billed or wages incurred but not yet paid before the end of a given accounting period. When a company recognises accrued expenses at the end of the year, it means they are bills for which the exact amount is not known, and a portion of it is accumulating, hence the term “accrued.” For example, the company consumes electricity over two months, and the bills overlap within a given period.
The reason for the accrual basis for recording expenses is accuracy. The accrual method creates a balance sheet that reflects expenses as they come in, not when the company pays for them. When the company pays for accrued expenses, the bookkeeper adjusts entries to record the payment. The effect of accrual accounting is that the company can track these expenses whether paid or not.
What are accounts payable?
On the other hand, accounts payable is a liability account that typically includes short-term debts to creditors that have already been invoiced. These invoices must be paid within a prescribed period to avoid default. These are for goods and services used for business operations, e.g., inventory. They are different from accounts receivable, which is money owed to the company.
Accounts payable go under the current liabilities column in the balance sheet because they usually require payment within one year from the transaction date. Loan repayments and employee wages are typically not part of accounts payables on balance sheets.
A common type of accounts payable is the purchase of raw materials from a supplier by a manufacturer to produce goods. Many suppliers provide companies they serve with 30, 60, or 90 days payment terms. When this happens, the company essentially gets an extension of credit to generate revenues to pay for the materials at the end of the credit term. The manufacturer must pay for the raw materials within the given period or go into default.
Purchases on credit such as described above go on the balance sheet as accounts payable liability and the income statement as an expense. When you pay an item on the accounts payable column, the total amount decreases, as will the asset (money) used to pay for it.
Because accounts payable are recognised in the balance sheet as they occur, you will be able to see at a glance how much you owe in total to vendors and suppliers at any given time. Knowing this means you can plan how to meet your obligations and help you make informed decisions for future expenses and revenue.
Accrued Expenses and Accounts Payable Similarities
The confusion over accrued expenses and accounts payable is their similarities. They involve debt in some form, and accountants recognise them as expenses for the company. Both are current liabilities because they are due within a year. Under certain circumstances, an accrued expense can become an account payable.
Accrued expenses and accounts payable are critical indicators of a company’s financial health, so it is vital to get them right. However, it can be tricky for non-accountants to identify which expenses should go under accrued expenses vs accounts payable because of these similarities, and even accountants sometimes get confused.
The Difference Between Accrued Expense and Accounts Payable
Accounts payable and accrued expenses represent critical business expenses that keep your company going. Even a home-based business run by one person incurs expenses, and they need to go on the record. The problem is knowing the critical differences between accounts payable and accrued expenses. Knowing that can help you make informed decisions and manage your money correctly. Below is an excellent infographic showing the fundamental differences of accounts payable vs accrued expenses in a side-by-side comparison.
|Examples of Accrued Expense and Accounts Payable|
Accrued Expense Example
|Employees render services to the company before they receive their wages. Wages are a recurring expense that is not invoiced or billed. Employees may have wages due that the company may not have paid yet at the end of an accounting period.|
Accrued Expense Example
|Most companies lease their places of business for a monthly fee, which often comes with yearly increases. The lease contract serves as a basis for estimating the rental payment.|
Accounts Payable Example
|A manufacturing company buys raw materials from a supplier, giving the manufacturer 30 days to pay for the raw materials. Within those 30 days, the manufacturer can produce and sell goods that will provide them with the funds to pay the supplier.|
Accounts Payable Example
|A restaurant buys a new industrial oven from a distributor, making a 50% down payment and promising to pay the balance within 60 days. The distributor delivers the oven with an invoice that stipulates the balance will be due within 60 days of delivery. Only the 50% balance goes into the accounts payable line of the balance sheet.|
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Manage Your Accrued Expenses and Accounts Payable
The whole point of trying to understand the difference between accounts payable and accrued expenses is to track your business expenses and obligations. You will not be in business for long if you fail to pay your bills on time or default on creditors simply because you could not manage them properly.
You can avoid these problems by using an automated system for managing your payables. Spenmo is a unified cloud-based payment platform that has helped many SMBs process more than $250 million in payments in Southeast Asia. The Singapore-based company provides businesses with a cost-effective way to manage day-to-day spending by issuing and tracking company cards, automating invoice payments, approval-based expenditure, and accounting, and keeping a digital ledger of all transactions.
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Frequently Asked Questions
Are accounts payable debit or credit?
It can be both. In accounting, accounts payable is a liability account, so it must have a credit balance that shows what the company owes a vendor. In that sense, it can be either a credit or a debit.
Why are accounts payable not an expense?
The accounts payable are liability accounts, meaning it represents something that a company must pay, but it is not an expense in itself. The funds that will pay a specific account payable are recorded as an expense when recorded under accrual accounting.
Where do accrued expenses go?
Accrued expenses go in the current liabilities column in a company's balance sheet to reflect future payments that have not been invoiced and are not yet known. Once the company receives an invoice for an item, it moves that item and the associated amount to accounts payable.