If you’re thinking about joining the accounting profession, you’re more than likely to be familiar with the terms ‘Accounts Payable’ and ‘Accounts Receivable’, but what exactly do they mean?
Here, we’ll explain in more detail…
Accounts payable
These are sums of money that a company owes due to purchasing services or goods on credit from a supplier. Accounts payable = a current liability.
Accounts receivable
These are sums of money a company has a right to collect due to selling services or goods on credit to a customer. Accounts receivable = a current asset.
Here’s an example…
Company A sells goods to company B on credit. Usually an invoice would be issued stating that the amount is due to be paid in 30 days. Company A will therefore record a sale and record an account receivable. Company B will record the purchase – usually as inventory – and will also record an account payable. Company A has a sale and a receivable, Company B has a purchase and a payable.
What’s the difference?
So, the terms are the opposite of each other… When a company purchases goods/services on credit, it will increase its accounts payable (current liability). When a company sells goods or services on credit, it will increase its account receivable (current asset).
As with any business transaction, one company’s purchase is another company’s sale, so the accounts payable of one company, will be the accounts receivable of another company. This is otherwise known to accountants as ‘symmetry’.
A further illustration of this… ‘Keely’s Kitchen’ receives £2,000 worth of goods from ‘Simple Supplies’ on credit. The transaction will result in Keely recording a £2,000 accounts payable (and a purchase), and Simple Supplies recording a £2,000 accounts receivable (and a sale).
How accounts payable affect a business…
Accounts payable will decrease a company’s cash flow as it is money that the company owes to others. They are recorded as ‘a liability’.
How accounts receivable affect a business…
Accounts receivable will increase a company’s cash flow as it is money that others owe to the company. They are recorded as ‘an asset’.
Abbreviations to consider…
Accounts payable is recorded in the General Ledger as ‘AP’ or ‘A/P’, whilst Accounts receivable is recorded as ‘AR’ or ‘A/R’.
Can you guess what General Ledger is recorded as? If you said ‘GL’, then yes, you’d be 100% correct.
