What is Accounts Payable (AP) in accounting? How are accounts payable classified, recognised, measured, and presented on the financial statements, and what are the main accounting journals for purchases, accruals and payments of creditors.
What is Accounts Payable (AP) in accounting?
The Accounts payable (AP) accounting ledger, represent the amounts a company owes to creditors or suppliers in short-term (up to 12 months or one accounting period). The accounts payable are recorded in Statement of Financial Position (Balance Sheet) under the current liability account. Some examples of accounts payable are listed below:
- Raw materials i.e. inventory
- Equipment i.e. plants or construction equipment, furniture, office supplies.
- Transportation and logistics i.e. cost of delivering goods, storage, logistics software.
- Maintenance i.e. insurance, revisions, repairs.
- Leasing i.e. leasing of equipment or motor vehicles.
- Licensing i.e. cost of obtaining licenses and monthly/annually licences fees.
- Software i.e. accounting software, inventory management software.
- Travel expenses i.e. transportation, meals, accommodation.
- Other services i.e. cleaning, or other utility bills such as water, electricity, heating.
What are the main responsibilities of Accounts payable (AP) department?
Accounts payable (AP) can refer as well as the department within a company responsible with managing the purchases, recording and payment of creditors and suppliers. Some of the responsibilities of the accounts payable department could be purchasing inventory or other service, managing inventories, office supplies, reimbursements, or petty cash management.
The Account Payable (AP) processing can be done manually or automated with the use of accounts payable software, and the main functions of account payable are described below:
- Recording payables
- Approval of payables
- Authorizing payments
- Releasing payments
Recording payables
Once the invoices are received from suppliers either in a physical or electronic format the accounts’ payable function is to capture and records the invoice information in the account’s payable ledger with all the necessarily information as supplier name, address, description, amount, VAT and so on.
In the same way for other creditors the accounts payable should look at the contract and agreements and record all the information necessarily for further reference when dealing with payments, discounts or interest.
Approval of payables
The account payable department have the responsibility to monitor the due date of invoices and to approve the payment of invoices taking in consideration the hyperarchy established by the company in terms of responsible person for approval, company needs and in terms of the supplier contracts agreed. During the approval process some of the checks that are performed before authorizing payment are the assessment of accuracy of information on the invoices, payment terms agreed with the supplier or discounts received.
For other payables to banks, lenders and so on the accounts payable is responsible as well to monitor the due dates, and contract agreements to make sure the information recorded in the accounts payable ledger is, accurate, reliable, up to date and correspond to the terms agreed with the creditors.
Authorizing payments
The payments of the invoices or other payments to creditors must be authorised by an appointed staff member in accordance with the company hierarchy. When authorising a payment some checks are in place to make sure the payment amount is in concordance with the invoice payable or with the terms agreed with the creditors.
Releasing payments
Once payment is approved the account payable department will manage the releasing of payment as per the terms agreed with the creditors. Therefore, the payment can be in form of cash, direct debit, cheque, bank transfer or another form agreed with creditors that are as well within the legal framework specific to the location where the company and creditor are established.
Now days most of the Accounts Payable (AP) departments are using advances accounting software’s to integrate the accounting, purchasing and payments software with banks and payment institutions and automize the accounts payable processes and tasks to gain more efficiencies within the process and achieve effective cost reductions.
What are the main types of Accounts Payable (AP)?
Accounts Payable (AP) is a more general term that means all the money a company owes to suppliers and other creditors in short-term as recorded in the current liabilities on the Statement of financial Position (Balance Sheet) Therefore, include all types of accounts payables such as trade payables, expenses payables, deferred payments contracts and accrued expenses.
Trade payable: Are directly short-term obligations related to the company’s core business activities that arise from the purchase of inventory or raw materials on credit terms and represent the amounts owed to suppliers for goods and services bought on credit that will be used in the normal course of business operations.
Deferred payment contracts: When the company is looking to improve the cash flow management can enter into agreement with contractors and suppliers to defer the payments by surpassing standard credit terms by agreeing to an extension of the actual due dates.
Expenses payable: The expenses payable is referring to the amount owed to the vendors for bills received in relation mainly to the company overheads as electricity, water, and other services.
Accrued expenses (accruals): These types of expenses are the costs that a company recognizes during the financial year for expenses such as utility bills, legal and professional fees, salaries, tax estimates or other expenses that are incurred and recognised within the current financial year before it receives an invoice and will be paid in the future. This accrual method of accounting is based on the matching principle, which states that all revenue and expenses must be reported in the same period and matched to determine profits and losses for the period.
In addition, this is an important part of the accounting and presentation of financial statements as guided by International Financial Reporting Standards (IFRS), Generally Accepted Accounting Principles (GAAP), International Accounting Standards, IAS 1 – Presentation of Financial Statements and IAS 37 – Provisions, Contingent Liabilities and Contingent Assets
What are the main International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) for Accounts Payable (AP)?
The most used accounting standards for Account Payable (AP) are released by the International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (GAAP)
Within the recent years the GAAP and IFRS have tried to synchronize on many accounting standards with the aim to reduce differences between the two frameworks, but there are still differences in the application of these standards in practice. Therefore, the companies must consult professional accountants or auditors to ensure compliance with US GAAP reporting requirements.
These standards define the main provisions for recognising, measurement, subsequent measurement, presentation and disclosures of Accounts Payable (AP) as summarized below:
What are the IFRS and GAAP provisions for the recognition standards of Accounts Payable (AP)?
IFRS: Accounts Payable (AP) are recognized when an entity has received goods or services from a supplier and has an obligation to make a payment for those goods or services in the future as per the terms agreed with the supplier. It is important to notice that the company must hold an evidenced in terms of a legal document i.e. invoice or legal contract as a legal proof or purchase.
GAAP: Under the Generally Accepted Accounting Principles (GAAP) the Accounts Payable (AP) are recognised in a similar way as per IFRS when there is an obligation to pay for goods or services, that is evidenced by a legal document i.e. invoice.
What are the main IFRS and GAAP provisions for measurement standards of Accounts Payable (AP)?
IFRS: Under the International Financial Reporting Standards (IFRS) the Accounts Payable (AP) are initially measured at the fair value of the consideration to be paid, that represents the invoiced amount net of any trade discounts, rebates, or allowances if they are offered as part of the purchase agreement.
GAAP: The Accounts Payable (AP) as per the Generally Accepted Accounting Principles (GAAP) as like the IFRS standards and are initially measured at the invoice amount, which is typically considered to be the fair value of the amounts payable. Similarly to the IFRS the trade discounts, rebates, or allowances are netted against the initial measurement if they are offered as part of the purchase agreement.
What are the IFRS and GAAP standards provisions for subsequent measurement of Accounts Payable (AP)?
IFRS: Under the International Financial Reporting Standards (IFRS) after initial recognition and measurement the Accounts Payable (AP) are measured subsequently at amortized cost, which is mainly the initial measurement amount minus any payments made and other applicable interest or finance charges.
GAAP: Under the Generally Accepted Accounting Principles (GAAP) the Accounts Payable (AP) after initial recognition, and measurement are measured subsequently similarly to the IIFRS with the difference that interest or finance charges related to accounts payable are generally not included unless they are significant and separately negotiated.
What are the main IFRS and GAAP provisions for the presentation standards of Accounts Payable (AP)?
IFRS: As per the International Financial Reporting Standards (IFRS) the Accounts Payable (AP) are presented on the Statement of Financial Position (Balance Sheet) as current liabilities, usually under the Trade and Other Payables if the payment is expecting to be settled within one year or one accounting period. Otherwise, if the payment is expected to exceed one year or one accounting period the Accounts Payable (AP) will be classified as non-current liabilities.
GAAP: The Accounts Payable (AP) under the Generally Accepted Accounting Principles (GAAP) are presented like IFRS on Statement of Financial Position (Balance Sheet) as current liabilities usually under the Accounts Payable or Trade Payables headings. In the same way as per IFRS if the settlement is expected to exceed one year or one accounting period the Accounts Payable (AP) will be classified as non-current liabilities.
What are the main IFRS and GAAP provisions for the disclosures standards of Accounts Payable (AP)?
IFRS: Under the International Financial Reporting Standards (IFRS) businesses are required to disclose within the financial statements notes all the carrying amounts of the Accounts Payable (AP), disclosure of all guarantees related to the Accounts Payable (AP), the significant accounting policies, and the terms and conditions of Accounts Payable (AP)
GAAP: Under the Generally Accepted Accounting Principles (GAAP) the businesses disclosures requirements are like the IFRS standards, and the entities are required to disclose within the financial statements notes all the carrying amounts of the Accounts Payable (AP), disclosure of all guarantees related to the Accounts Payable (AP), the significant accounting policies, and the terms and conditions of Accounts Payable (AP)
What are the main standards requirements for Accounts Payables (AP) under the IAS 37 – Provisions, Contingent Liabilities and Contingent Assets
As per IAS 37 – Provisions, Contingent Liabilities and Contingent Assets a provision a liability of uncertain timing or amount whereas a liability and contingent liability /asset are described below:
A liability is where the two requirements below are meet:
- A present obligation arises because of past events.
- The settlement is expected to result in an outflow of resources i.e. payment.
A contingent liability is when one of the two requirements below are meet:
- A possible obligation depending on whether some uncertain future event occurs.
- A present obligation but payment is not probable, or the amount cannot be measured reliably.
A contingent asset is where the two requirements below are meet:
- A possible asset that arises from past events.
- The possible asset existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.
Recognition of a provision as per IAS 37 – Provisions, Contingent Liabilities and Contingent Assets
A company should recognise a provision if the three requirements below are meet:
- There is a present obligation (legal or constructive) that has arisen because of a past event.
- A payment for settlement of liability is highly probable
- The amount for the liability settlement can be estimated reliably.
Measurement of provisions as per IAS 37 – Provisions, Contingent Liabilities and Contingent Assets
For the measurement of the provision recognised under the IAS 37 – Provisions, Contingent Liabilities and Contingent Assets standards the company should make an accurate estimate of the amounts required to settle the present obligation.
At the same time the company should consider the risks and uncertainties that surround the underlying events that could occur and influence the amount estimated for the settlement of the provision, and the amount recognizes should not exceed the amount estimated for the provision settlement.
Subsequent measurement and disclosure of a provision as per IAS 37 – Provisions, Contingent Liabilities and Contingent Assets
The company must review and adjust provisions at the end of each financial year, and if an outflow no longer probable, provision will be reversed.
The disclosures requirement for each class of provisions are the opening balances, additions, used/unused amounts, other discounts, closing balance, and a brief description about the provisions as the nature of the provision, term, assumptions, reimbursements or uncertainties.
How to account and what are the main journal entries for Accounts Payable (AP)?
Accounts Payable (AP) are dealing with the purchases of goods or serviced on credit from suppliers and the entity must record each transaction in the purchase leger within the company books of accounts. The recording of each transaction within the purchase ledger and the accounting journal entry within the books of accounting must have a debit and a credit side and reflect the information as per the documentation received from the supplier when the purchase and settlement are taking place.
When an entity is purchasing goods or services from suppliers, firstly must record into the purchase ledger all the information as per the documentation received from supplier that evidence the information, terms and conditions of the purchase.
Subsequently the bookkeeper will record the purchase and settlement (payment) withing the books of accounting as per the information received and stored withing the purchase ledger. A few examples of journal entries for trade payables, expenses payable or accruals are outlined below:
Trade payable: when a company is purchase and subsequently is paying for goods (inventory) on credit the main double entry accounting journal are outlined below:
Double entry accounting journals for the purchase of goods (inventory)
- Credit (CR): Statement of Financial Position (Balance Sheet) – Accounts Payable (AP)
- Debit (DR): Statement of Financial Position (Balance Sheet) Assets – Inventory
Double entry accounting journals for the settlement of goods (inventory) purchased on credit
- Credit (CR): Statement of Financial Position (Balance Sheet) – Cash
- Debit (DR): Statement of Financial Position (Balance Sheet) – Accounts Payable (AP)
Expenses payable: when a company is recording the fees due and subsequently the settlement for services i.e. accounting and bookkeeping due for settlement in the future the main double entry accounting journal are outlined below:
Double entry accounting journals for recording accounting and bookkeeping services due for settlement later in the future:
- Credit (CR): Statement of Financial Position (Balance Sheet) – Accounts Payable (AP)
- Debit (DR): Income Statement (Profit & Loss) – Accounting and Bookkeeping Expenses
Double entry accounting journals for recording accounting and bookkeeping settlement for services received in the past:
- Credit (CR): Statement of Financial Position (Balance Sheet) – Cash
- Debit (DR): Statement of Financial Position (Balance Sheet) – Accounts Payable (AP)
Accrued expenses (accruals): as an example, when a company is accruing and subsequently paying for utility bills i.e. electricity that are due for settlement later in the future when the bills are received the main double entry accounting journal are outlined below:
Double entry accounting journals for recording the accruals of the electricity services due for settlement later in the future when the bills are received:
- Credit (CR): Statement of Financial Position (Balance Sheet) – Accounts Payable (AP)
- Debit (DR): Income Statement (Profit & Loss) – Electricity Expenses
Double entry accounting journals for recording the settlement of accrual expenses of the electricity services:
- Credit (CR): Statement of Financial Position (Balance Sheet) – Cash
- Debit (DR): Statement of Financial Position (Balance Sheet) – Accounts Payable (AP)
To note for settlements (payments) of suppliers some procedures are required as agreements between the company and its suppliers are frequently present, that influence the credit terms and conditions. As an example, some suppliers might only give credit for one month, whereas other suppliers might offer a longer grace period before payment is due. At the same time before releasing the payment the invoices must be approved and payment authorised by responsible persons as per each entity hierarchy.
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