Accrued Expenses vs. Accounts Payable: An Overview
Companies must account for any expenses incurred in the past as these are costs that come due in the future. Accrual accounting is the general accounting term that covers any of these liabilities and there are two methods that companies use to track these accumulated expenses: accrued expenses or accounts payable.
Both are liabilities that businesses incur during their normal course of operations but they are inherently different. Accrued expenses are liabilities that build up over time and are due to be paid. Accounts payable, on the other hand, are current liabilities that will be paid in the near future. In this article, we go into a bit more detail describing each type of balance sheet item.
- Accrued expenses and accounts payable are two methods companies use to track accumulated expenses under accrual accounting.
- Accrued expenses are liabilities that build up over time and are due to be paid.
- Accounts payable are liabilities that will be paid in the near future.
- The amount owed under an accrued expense can change as it may be an estimate while an accounts payable comes at a fixed amount.
- Accrued expenses are adjusted and recorded at the end of an accounting period while accounts payable appear on the balance sheet when goods and services are purchased.
Accrued expenses are payments that a company is obligated to pay in the future for goods and services that were already delivered. Put simply, a company receives a good or service and incurs an expense. This expense is recorded on the books but is paid later.
The term accrued means to increase or accumulate so when a company accrues expenses, this means that its unpaid bills are increasing. Expenses are recognized under the accrual method of accounting when they are incurred—not necessarily when they are paid.
Also called accrued liabilities, these expenses are realized on a company's balance sheet and are usually current liabilities. Accrued liabilities are adjusted and recognized on the balance sheet at the end of each accounting period. Any adjustments that are required are used to document goods and services that have been delivered but not yet billed.
So what constitutes an accrued expense? Examples include:
- Utilities used for the month but an invoice has not yet been received before the end of the period
- Wages that are incurred but payments have yet to be made to employees
- Services and goods consumed but no invoice has been received yet
Balance sheets are financial statements that companies use to report their assets, liabilities, and shareholder equity. It provides management, analysts, and investors with a window into a company's financial health and well-being.
The term accounts payable (AP) refers to a company's ongoing expenses. These are generally short-term debts, which must be paid off within a specified period of time, usually within 12 months of the expense being incurred. As such, they are short-term IOUs issued by billing parties. Companies that fail to pay these expenses run the risk of going into default, which is the failure to repay a debt.
An accounts payable is essentially an extension of credit from the supplier to the manufacturer and allows the company to generate revenue from the supplies or inventory so that the supplier can be paid. This means that companies are able to pay their suppliers at a later date. This includes manufacturers that buy supplies or inventory from suppliers. In other words, suppliers extend the terms for the payment.
Accounts payable (or payables as they're often called) might not be due for another 30, 60, or 90 days. As such, they are considered current liabilities. Companies recognize their payables on the balance sheet when they purchase goods or services on credit. This requires a double-entry on the general ledger:
- A credit to the company's accounts payable upon receipt of the invoice
- An offsetting debit under the expense account for the credit purchase
We've highlighted some of the obvious differences between accrued expenses and accounts payable above. But the following are some of the main factors that set these two types of costs apart.
Accrued expenses are the total liability that is payable for goods and services consumed or received by the company. All companies have accrued expenses. But they reflect costs in which an invoice or bill has not yet been received. As a result, accrued expenses can sometimes be an estimated amount of what's owed, which is adjusted later to the exact amount, once the invoice has been received.
Accounts payable, on the other hand, is the total amount of short-term obligations or debt a company has to pay to its creditors for goods or services bought on credit. With accounts payables, the vendor's or supplier's invoices have been received and recorded. Payables should represent the exact amount of the total owed from all of the invoices received.
Some of the other differences between these two expenses include:
- The recipient: Companies pay accrued expenses to their employees, property owners, and banks. Salaries, rent, and interest are common accrued expenses that companies owe. Accounts payable, on the other hand, are owed to creditors, including suppliers for goods and services purchased on credit.
- Occurrence: Accrued expenses tend to be regular occurrences, such as rent and interest payments on loans. Accounts payable, though, only occur when a business makes a purchase on credit.
|Differences Between Accrued Expense and Accounts Payable|
|Accrued Expense||Accounts Payable|
|Types||Employee wages, rent, and loan interest||Supplies, raw materials, and any other orders made with suppliers and vendors|
|Accounting||As current liabilities on the balance sheet||As accounts payable on the balance sheet|
|Realization||At the end of the accounting period||When the expense is incurred, such as the time an order is placed|
|Payable to||Employees, property owners, and banks||Suppliers, vendors, and other creditors|
|Occurrence||Regular occurrences for all companies||When purchases/orders are made on credit|
Accrued Expenses vs. Accounts Payable Example
Here's a hypothetical example to demonstrate how accrued expenses and accounts payable work. Let's say a company that pays salaries to its employees on the first day of the following month for the services received in the prior month. This means an employee who worked for the entire month of June will be paid in July. If the company’s income statement at the end of the year recognizes only salary payments that have been made, the accrued expenses from the employees’ services for December will be omitted.
By contrast, imagine a business gets a $500 invoice for office supplies. When the AP department receives the invoice, it records a $500 credit in the accounts payable field and a $500 debit to office supply expense. As a result, if anyone looks at the balance in the accounts payable category, they will see the total amount the business owes all of its vendors and short-term lenders. The company then writes a check to pay the bill, so the accountant enters a $500 credit to the checking account and enters a debit for $500 in the accounts payable column.
When Should You Accrue an Expense?
Companies usually accrue expenses on an ongoing basis. They are current liabilities that must be paid within a 12-month period. This includes things like employee wages, rent, and interest payments on debt owed to banks.
How Are Accrued Expenses Recorded?
Accrued expenses are listed on a company's balance sheet. They should appear at the end of the company's accounting period. Adjustments are made using journal entries that are entered into the company's general ledger.
What Are Examples of Accounts Payable?
Accounts payable refers to any current liabilities incurred by companies. Examples include purchases made from vendors on credit, subscriptions, or installment payments for services or products that haven't been received yet. Accounts payable are expenses that come due in a short period of time, usually within 12 months.
Is Rent an Accounts Payable?
Rent is generally not considered part of accounts payable. Rather, companies incur rent as an accrued expense. That's because this is a cost that is paid consistently and monthly.