Is Accounts Payable Liability or Asset?
Every financial activity a company performs requires an accounting entry. Since a good chunk of these entries belongs to either the asset or liability account in the balance sheet, it can get confusing, especially for new business owners, to determine where a particular sub-account belongs.
So, is accounts payable asset or liability? We’ll be answering that right away: AP is considered a liability, and it goes into your balance sheet as a “current liability.” Accounts payable is an essential aspect of a company’s finances, and understanding what it is and where it goes in your records and reports is crucial.
To understand why AP is considered a liability, you need to know what AP is all about. You’ll also need to understand what the asset and liability accounts represent. If you’re wondering about all of that, stick around because this article is for you.
Let’s begin with the basics.
What Are Accounts Payable?
Accounts payable are short-term debts a business incurs whenever it purchases goods or services on credit from vendors. Buying raw materials, supplies, services, or inventory stock without paying cash straight away happens all the time in the business world.
Still, businesses need to repay these short-term debts within the agreed-upon terms to avoid incurring penalties and interest. Terms typically span 30 days to a few months, but not more than one year.
Whenever you purchase on credit, you’ll have to record the non-cash transaction into your general ledger, which you later re-record in the balance sheet’s accounts payable account under current liabilities.
What’s So Important About AP?
Accounts payable impacts a business’s cash flow. Simply put, good AP performance contributes to an overall positive cash flow. Bad AP performance does the opposite. Making the most out of cash flow with AP comes down to this simple general rule: Never pay your bills too early or too late.
Think about it; the longer you don’t pay for your purchases, the more money you’ll have available, contributing to a positive net cash flow since you’re keeping cash in company hands. On the other hand, if you consistently pay vendors too early, you’ll have a lower AP, but you’ll also have less cash on hand, making your cash flow lean towards a deficit.
Now, you also don’t want to pay too late, not if you want to maintain good relationships with your vendors. Great vendor relationships give you more opportunities to negotiate longer and leaner terms, which, as you already know, can positively influence cash position.
Automation helps when it comes to ensuring your company uses available resources as efficiently as possible. Apart from streamlining repetitive AP functions, automation can help your team stay on top of vendor invoices, ensuring you never pay too early or too late.
Learn more on how automating with Peakflo can benefit your entire AP process.
Assets & Liabilities: What Are They?
Now that you understand what AP is all about, we’ll brush up on the basics of assets and liabilities to help you further understand how AP gets to be a liability.
Assets and liabilities are two of the six major accounts in double-entry bookkeeping. Both also significantly affects cash flow.
What Are Assets?
Assets are any resources your company owns and controls. These resources help your business generate present and future cash flow. Assets also add value to your company’s equity, increasing its net worth. You’ll find all the different asset sub-accounts in your balance sheet.
Asset accounts fall into two general categories in terms of liquidity:
- Current Assets are your company’s most liquid assets since they’ll convert into cash in less than one year. Examples include cash, cash equivalents, inventory, accounts receivable, and marketable securities like stocks or bonds.
- Fixed Assets are less liquid than current assets since they’ll take more than a year before you can turn them into cash. Examples include land, buildings, and equipment. If it’s something you don’t intend to sell or liquidate in less than a year, it’s a fixed asset.
You can also classify assets based on physical existence:
- Tangible Assets are any assets that you can physically interact with and have a physical form. Examples include current and fixed assets like cash, inventory, land, and equipment.
- Intangible Assets include those that lack physical existence. You can also consider patents, copyrights, trademarks, or trade secrets as assets, but they fall under this classification since they’re not tangible.
Assets can also be classified based on usage, which means they’re either operating or non-operating assets.
What Are Liabilities?
Liabilities are your company’s obligations to others, whether to a bank, a utility provider, or a vendor. Think of it as the exact opposite of assets. While assets are things your company owns, liabilities are things your company owes. You can also find liabilities on a balance sheet.
Liability accounts can also be classified based on cash convertibility:
- Current Liabilities are obligations that your company must settle in less than a year. You can pay these short-term responsibilities using current assets like cash. Examples include short-term bank loans, dividend payables, and accounts payable to vendors.
- Long-Term Liabilities are also obligations that you must settle, but they won’t be due until after one year. Examples include long-term debts or other payables due after more than 12 months.
Is Accounts Payable Asset Or Liability?
Accounts payable are short-term debt with a typical turnover of fewer than 12 months – usually lasting just 30 to 90 days at most. Remember that current liabilities are obligations that must settle in less than a year – making AP a prime example.
While AP helps keep cash flow circulating, it’s not considered an asset since it represents a responsibility that you must pay in the near future.
Companies record AP on a balance sheet alongside similar current liabilities like short-term bank loans and tax payables.
Accounts Payable & Accounts Receivable: The Difference
AP and AR are often confused with one another, especially with budding entrepreneurs just getting a hold of how things are in double-entry bookkeeping. Contrary to accounts payable, accounts receivable is a current asset. While AP is the combined amount of what you owe to suppliers, AR, in turn, is the combined amount customers owe you for purchasing your goods or services.
For example, say you buy inventory stocks worth $5,000 from a vendor on credit. Your vendor provides a 30-day term before you can make a repayment. Upon receiving the goods, you’ll have to record the $5,000 credit purchase in the general ledger and balance sheet, respectively.
This transaction increases your AP account under current liability by $5,000 until you pay back your vendor after 30 days. In turn, your vendor records a $5,000 increase in their balance sheet’s accounts receivable account, which they remove after you make your repayment.
How To Record AP On A General Ledger
In double-entry bookkeeping, every business transaction affects at least two different accounts. So, for every transaction, you’ll have to debit one account while crediting another.
Using the above example, you’ll have to record the credit purchase on the general ledger in this way:
March 01, 2022
Accounts Payable/Current Liability
Your credit purchase affects two separate accounts: inventory, which is a current asset and accounts payable, which is a current liability.
As a general rule, an increase in an asset account is a debit, while a decrease is a credit. Meanwhile, an increase in a liability account gets a credit, while a decrease gets a debit.
In this example, inventory was debited since it’s a current asset, and accounts payable got a credit since it’s a current liability.
After you pay your vendor 30 days later, you’ll have to make another journal entry.
March 31, 2022
Accounts Payable/Current Liability
This time around, you’re decreasing your AP liability account since you’re making repayments. Concurrently, the cash asset account also drops since you use funds to pay the short-term debt.
How Does AP Show On A Balance Sheet?
The balance sheet is one of three crucial financial reports organizations use to gauge their financial health. The other two are the income statement and the cash flow statement. Companies also create projections of these reports to map out their financial future.
The balance sheet reflects the total amounts of three major accounts: assets, liabilities, and owner’s equity, during a specific period.
Simply put, these accounts allow a business to get a clear view of what it owns (assets), owes (liabilities), and what’s going to be left for the company’s owners (owner’s equity).
Example of AP in the Balance Sheet
A company’s balance sheet is a snapshot in time, meaning it does not show performance in terms of periods, but rather how it is at the moment. A balance sheet displays a fundamental accounting equation, which states that total assets are always equal to the sum of liabilities and owner’s equity.
To see how accounts payable gets reflected on a balance sheet, take a look at this example:
- As you may have anticipated, AP appears under current liabilities.
- AP is one of current liability’s top-line items since it has the shortest turnover compared to other line items like interest and tax payables.
- In this example, AP has an aggregate value of $80,000, making up a considerable portion of total current liabilities.
- Overall liabilities (current + long-term liabilities) total $450,000, 33% of which is current liabilities, and 17% accounts payable.
Hopefully, this sheds some light on the question “is accounts payable asset or liability.” To recap, AP is a liability since it represents a short-term debt your company must settle to vendors soon. It’s recorded as a current liability on a balance sheet because of its quick turnover, lasting from 30 days to a few months, but not more than one year.
Accounts payable affect cash flow since it allows a company to keep cash instead of giving it right away. Anytime a company makes a credit purchase, AP increases. And as soon the company makes the repayment, AP decreases.
AP management is essential to every business’s financial management. Accounts payable automation makes it easy for any AP team to handle their company’s accounts payable. With Peakflo’s automation, your accounting pros can say goodbye to time, and resource-intensive tasks, ultimately cutting costs on your AP admin expenses while putting your invoice payments on accurate auto-pilot.