Accounts Payable: Asset or Liability

Accounts payable is a critical concept for any business owner. Understanding how to work with accounts payable and understanding accounts payable as a liability or an asset is essential for accurate financial reporting. Let’s dive into the details of accounts payable and clarify its true nature.

Understanding Accounts Payable

Definition of Accounts Payable

Accounts payable (or AP for short) refers to the amounts a company owes its suppliers or vendors for goods and services received but not yet paid for.

Got a bill from your supplier? Congratulations, you get to record accounts payable! Unless it’s due immediately, your vendor will typically write credit terms of NET30 or NET60 days on their bill, meaning you are obligated to pay within 30 or 60 days.

Importance in Financial Management

Effective management of accounts payable is crucial for maintaining good relationships with suppliers and ensuring smooth operations in a business. We’ve got some great articles on cash flow challenges, including how to handle accounts payable when cash is tight.

Is Accounts Payable a Liability?

Yes. Accounts Payable is a Liability. It is considered a short-term liability on the balance sheet, meaning your company has a debt to pay, typically within one year.

Characteristics of Liabilities

In accounting, a liability is defined as a company’s legal financial debts or obligations that arise during the course of business operations. These obligations are settled over time through money, goods, or services. Liabilities are recorded on the balance sheet and are categorized into two main types: current liabilities and long-term liabilities.

Aside from accounts payable, other examples of liabilities that small-business owners usually see include:

  • Loans: Amounts borrowed from financial institutions that need to be repaid with interest.
  • Accrued Expenses: Expenses that have been incurred but not yet paid, such as wages and taxes owed.
  • Unearned Revenue: Money received from customers for products or services that have not yet been delivered.

How Accounts Payable Meets Liability Criteria

Got all that? Ok so how does accounts payable fit into the definition of a Liability? 1) it’s a debt and it must be repaid 2) it has nothing to do with equity/shares in the company.

Is Accounts Payable an Asset?

Defining Assets in Business

An asset is defined as a resource owned by a business that is expected to provide future economic benefits. Assets are recorded on the balance sheet and can be categorized into various types, including current assets, fixed assets, and intangible assets.

For a small business owner, examples of assets include:

  • Cash: The money available for daily operations.
  • Accounts Receivable: Money owed to the business by customers for products or services delivered but not yet paid for.
  • Inventory: Goods available for sale, which can be converted into cash when sold.
  • Intangible Assets: Brand names or logos that provide a competitive advantage and can enhance the business’s value.
  • Patents: Legal rights to produce or sell a specific invention or product, which can offer a unique market position.

Why Accounts Payable is Not Considered an Asset

Accounts payable is not considered an asset because it represents a company’s obligations to pay off its short-term debts. It does not refer to a resource that provides future benefits.

Example for Accounts Payable: Asset or Liability?

Accounts Payable is definitely a liability, but it can be confusing when you’ve purchased an asset from a supplier – like some new inventory. You need to record that you now own the inventory, and you also need to record what you owe to the supplier. Where do you put the asset or liability debits and credits? Let’s walk through this with an example.

Balancing Accounts Payable in Financial Statements

Let’s look at how to record accounts payable transactions in the books after receiving an invoice from a supplier for some inventory you’ve purchased:

Step 1: Recording the Accounts Payable Transaction

When you receive an invoice, you need to record it as a liability. Here’s how to do it:

  • Debit the Asset Account: this reflects the cost of the inventory purchased. Example: If you receive an invoice for $1,000 for inventory, you would debit the Inventory account by $1,000. Remember: to ‘increase’ an asset account you ‘debit’ it.
  • Credit the Accounts Payable Account: This reflects your obligation to pay the supplier in the future for $1,000. Remember: to ‘increase’ a liability account, you ‘credit’ it.

Step 2: Recording the Payment to the Supplier

When you pay the supplier, you will need to record the transaction to decrease the accounts payable. Here’s how to do it:

  • Credit the Cash/Bank Account: This reflects the outflow of cash to pay the supplier. Example: You would credit the Cash or Bank account by $1,000.
  • Debit the Accounts Payable Account: This reflects the reduction of your obligation now that you are making the payment. Example: You would debit the Accounts Payable account by $1,000.

Notice that we don’t touch the inventory account in this second step. We still have the asset (the inventory) until it is sold, and there’s a whole other set of transactions for that.

Conclusion

In summary, Accounts Payable is a Liability. Your business commonly incurs AP by buying things from suppliers, with an agreement to pay them later. Recording Accounts Payable correctly (as a liability, and with the correct due date) is important for your cash flow management, your relationship with suppliers and your overall business health.

Most accounting for accounts payable is done automatically and effectively using cloud accounting software like Quickbooks Online. If it is set up correctly, and data (bills and payments) is entered near-real-time, then managing accounts payable becomes routine and easy. Please contact us for help with accounting software setup services and accounting services.

Helina Patience, CPA, CMA
Author: Helina Patience, Founder, CPA, CMA, BA (Hons), BEd

Helina is a CPA, CMA with over fifteen years of experience in finance & HR within multinational companies, across many industries. Also the CEO of entreflow consulting group where I help small to medium-sized businesses get organized, grow, and crush their goals. I hold vast global experience after living and working in Australia, India, the UK and Ireland. Connect on LinkedIn.

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