In the world of finance and accounting, accurate record-keeping is crucial for effective financial management. Two key concepts that play a significant role in ensuring accurate financial records are accounts payable and accrued expenses.
Although they may seem similar, understanding the differences between the two can help businesses manage their finances more effectively.
This article will explore the differences between accounts payable and accrued expenses.
What Are Accrued Expenses?
Accrued expenses, also referred to as accrued liabilities, are payments that a company is required to pay in the future in exchange for the goods and services received. The term “accrued” suggests an increase or accumulation, accruing expenses signify the rise of the company’s unpaid bills.
Essentially, when a company obtains a good or service, it incurs an expense and records it in its financial records, with the payment being made at a later date.
Following the accrual accounting method, expenses are acknowledged when they occur, rather than when payment is made.
Accrued expenses in the balance sheet are recorded as current liabilities and adjusted at the conclusion of each fiscal year to accommodate goods and services that have been provided but not yet invoiced.
What Are Accounts Payable?
Accounts payable (AP) is the company’s ongoing, short-term expense. Usually, AP is expected to be settled within a specific period, typically 12 months from the date the expense arises. Failure to pay these expenses may result in debt repayments.
Accounts payable is a credit line provided by a supplier to a company, enabling the company to generate revenue from supplies or inventory before making payment to the supplier at a later time. This practice is prevalent among manufacturers that procure supplies or inventory from suppliers, as the suppliers grant extended payment terms
Often referred to as payables, accounts payable might not be due for 30, 60, or 90 days, and therefore, they are categorized as current liabilities. Companies document their payables on the balance sheet upon purchasing goods or services on credit. This procedure requires a double entry in the general ledger:
- A credit entry in the company’s accounts payable when the invoice is received.
- A corresponding debit entry in the expense account for the credit purchase.
Differences Between Accounts Payable and Accrued Expenses
The distinction between accounts payable and accrued expenses is crucial for understanding a company’s financial health.
- Accrued expenses are liabilities owed for goods and services consumed but not yet invoiced, often estimated and later adjusted to the exact amount. Accounts payable, on the other hand, represents short-term debt owed to creditors for goods or services purchased on credit, with invoices already received and recorded.
- Generally, accrued expenses are related to the operating expense line item on the income statement, while accounts payable is associated with the cost of goods sold (COGS) line item.
- Accrued expenses apply to all companies and are owed to employees and banks, while accounts payable arises only when purchases are made on credit and involve payments due to creditors.
- Accrued expenses lack invoices, while accounts payable includes received invoices.
- Accrued expenses are recognized on the balance sheet at the accounting year’s end via adjusting journal entries, while accounts payable is recognized when a company buys products or services on credit.
Accounts Payable vs Accrued Expense Critical Differences (Table)
|Type||Accounts payable arises from the purchase of goods and services on credit. It typically involves invoiced amounts from suppliers. Accrued expenses result from costs incurred but not yet paid. These can include various expenses like wages, interest, rent, and utilities.|
|Balance Sheet||Accounts payable is classified as current liabilities. Accrued expenses can be categorized as either current or long-term liabilities, depending on the nature and duration of the underlying expense.|
|Realization||Accounts payable are realized when a company receives an invoice from a supplier. Accrued expenses are recognized when the expense is incurred, even if no invoice has been received.|
|Payable to||Accounts payable is the amount owed to suppliers, vendors, or creditors for goods and services purchased on credit. In contrast, accrued expenses can be payable to various parties, including employees (for wages), financial institutions (for interest), or utility companies (for utilities)|
Accounts Payable vs Accrued Expense Key Differences (Image)
Accounts Payable vs Accrued Expense Examples
To illustrate the differences between accrued expenses and accounts payable, let’s consider a few examples.
|Accrued Expense Examples||Accounts Payable Examples|
|Employee Payroll||Raw Material Purchases|
|Accrued Interest||Labor Costs|
|Monthly Building Rent||Transportation|
Example 1: Utility Expenses
A company receives its monthly utility bill on the 5th of the following month. The utility expense for the entire month is considered an accrued expense because it was incurred during the month but not yet paid. Once the company receives the utility bill, the amount owed is recorded as accounts payable, since it is now a formal obligation to pay the utility company.
Example 2: Wages
A business pays its employees bi-weekly, and the pay period ends on the 15th of the month. However, the payroll is processed, and employees are paid on the 20th of the month. The wages earned by employees from the 1st to the 15th are accrued expenses, as they have been incurred but not yet paid. On the 20th, when the payroll is processed, the accrued expense is eliminated, and the employees receive their wages.
Example 3: Interest Expense
A company takes out a loan and is required to pay interest on the borrowed amount. The interest is payable quarterly, but the company accrues the interest expense monthly. In this case, the interest expense is considered an accrued expense, as it is incurred monthly but not yet paid. At the end of the quarter, when the interest payment is due, the company records the amount as accounts payable, since it now has a formal obligation to pay the financial institution.
Make Your Accounts Payable Management Easier
In conclusion, while both accrued expenses and accounts payable are liabilities that a business incurs, there are some key differences between the two. Accrued expenses refer to expenses that have been incurred but not yet paid, while accounts payable are amounts owed to vendors or suppliers for goods or services that have already been received but not yet paid for.
To manage these liabilities efficiently, businesses can turn to automation solutions like Peakflo. With end-to-end AP automation, Peakflo can centralize and streamline procurement to payment processes, making vendor payment processes more efficient and budgeting more accurate and simple to analyze.
As Poetri, a Senior Finance and Tax Manager at Rey, can attest, Peakflo’s support team is approachable, supportive, and constantly updating the platform with new features to support business transactions.
If you’re looking to improve your AP processes and streamline your payments, consider giving Peakflo a try.