In a very small company with relatively straightforward transactions, a bookkeeper's general ledger might be limited to transactions where cash has already changed hands. These companies use cash basis accounting, which only records cash transactions and does not delve into sales based on credit.
When companies scale up, they frequently deal in the world of credit sales, where purchases are finalized before money actually transfers from one party to another. These companies use accrual accounting, which tracks incoming and outgoing cash before transactions actually occur. This is made possible by two special kinds of bookkeeping accounts: accounts payable, for money the company owes to others, and accounts receivable, for money that others owe to the company.
What is accounts receivable?
Accounts receivable refers to the category on a corporate balance sheet or income statement that itemizes any unpaid balances owed to the company by its customers. Receivable accounts serve two functions on financial statements. They are revenue accounts, showing the business’s income or the money that will soon be paid into the company. They are also current asset accounts, representing money that is part of the company’s net working capital.
On an accounts receivable ledger, any goods and services for which the company has issued an invoice are itemized. For example, a car battery supplier could ship a palette of units to an automobile manufacturer, extending credit to them on the purchase, meaning the carmaker can pay after the batteries have been delivered. Until the carmaker pays its bill, the purchase amount remains a ledger item in accounts receivable. When the payment comes through, the money shifts to cash on hand and is recorded in a cash flow statement—a financial document that records money flowing into and out of an organization.
What is accounts payable?
An accounts payable ledger on a balance sheet describes forthcoming transactions where the company must pay money to an outside party. Accounts payable is a liability account—it represents cash that will soon flow out of the company, thus lowering a company’s net value on a balance sheet.
Much like accounts receivable, accounts payable records ledger items for which an invoice has been issued—only this time, the invoice is submitted to the company itself. The company may have an ongoing relationship with a marketing agency, for instance, where the marketing agency bills once per month for services rendered.
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Until the marketer’s bill is paid, the expense sits in accounts payable. Once the money actually gets paid out, company bookkeepers record the transaction on a cash flow statement.
Accounts receivable vs. accounts payable: What’s the difference?
- Offset allowances
The accounts receivable and accounts payable accounting processes share much in common. The key distinction is that accounts receivable describes money expected to flow into the company, while accounts payable describes money that will soon flow out of the company. Other differences between accounts receivable and accounts payable include:
Accounts payable is a current asset account; it reports money that should soon flow into the company. Accounts receivable is a current liability account—it describes money that will soon leave the company.
Accounts receivable—but not accounts payable—sometimes involves a running balance called an offset allowance. The idea behind offset allowances is some accounts receivable balances may never be paid. Accountants call these “doubtful accounts.” An offset allowance is a sum of money the company stands to lose if doubtful accounts don’t pay their bills. The company will take a loss, and this will affect its overall bottom line.
When it comes to accounts payable, accountants and bookkeepers may not create offset allowances. If the company were to create an offset allowance for bills it (the company) owes, this suggests the company doesn’t intend to pay its bills. This action violates multiple generally accepted accounting principles (GAAP) that guides corporate finance.
Auditors review both accounts payable and accounts receivable to check for transparency and honesty, but are looking for different things in the two ledgers.
- When auditing accounts receivable, they check to make sure each ledger item ties to real-world invoices. They also look for doubtful accounts, bills that probably won’t be paid. They look to ensure a company’s bookkeepers aren’t inflating the business’s net worth by listing future income that won’t ever materialize. If it seems a company’s customers will never pay their bills, their balance must be moved from accounts receivable to current expenses. Auditors also confirm the company accurately lists all its accounts payable.
- When auditing accounts payable, auditors are looking for the opposite—companies can inflate their net worth by omitting bills from accounts payable. This effectively hides known liabilities from its shareholders, creditors, and potential investors.
Accounts receivable vs. payable FAQ
Are invoices sent to accounts payable?
In many cases, vendors send bills directly to a company’s department of accounts payable. Other companies have a general address for all correspondence—from customer inquiries to bills—and they later transfer invoices to accounts payable.
What are some examples of accounts payable?
A company may establish many open accounts payable in the course of normal business operations. Examples include payments owed to marketers, caterers, product suppliers, accountants, and governments (in the form of taxes).
What are some examples of accounts receivable?
Examples of accounts receivable include lawn care clients who pay at the end of every month or factories who pay after a piece of machinery is delivered. Bookkeepers also file promissory notes with accounts receivable. These notes are IOUs—they promise a certain amount of money that will be paid by an assigned date.
Can the same person do accounts payable and accounts receivable?
Yes, the same bookkeeper can record accounts receivable and accounts payable. Many small businesses can only afford a single bookkeeper. Such professionals must record all of the company’s financial transactions, whether they are in asset accounts or liability accounts.