Accounts Payable (AP) With Examples and How To Record AP

ByObeydul Haque Reading Time: 6 minutes

Accounts Payable (AP) is a fundamental concept in accounting and business operations, representing money a company owes to its suppliers or creditors for goods or services purchased on credit. It is a critical component of a company’s financial health and cash flow management. In this article, we’ll explore what Accounts Payable entails, provide real-world examples, and explain how businesses record AP in their accounting systems. Whether you’re a small business owner, an accounting student, or simply curious about financial processes, this guide will offer a comprehensive understanding of AP.

What Is Accounts Payable?

Accounts Payable refers to short-term liabilities that a business owes to its vendors or suppliers for goods or services received but not yet paid for. It typically arises when a company purchases items on credit, meaning payment is deferred to a later date, often within 30, 60, or 90 days, depending on the agreed-upon terms. AP is recorded on a company’s balance sheet under current liabilities because it is expected to be settled within one year or one operating cycle.

The AP process involves tracking invoices, verifying their accuracy, and ensuring timely payments to maintain good supplier relationships and avoid penalties or late fees. Efficient management of AP can also help businesses optimize cash flow, negotiate better terms with suppliers, and maintain a strong credit reputation.

For example, if a company orders $5,000 worth of office supplies from a vendor with payment terms of “net 30” (payment due in 30 days), that $5,000 becomes part of the company’s Accounts Payable until it is paid.

Why Is Accounts Payable Important?

  1. Cash Flow Management: AP allows businesses to delay cash outflows, giving them flexibility to use funds for other operational needs before settling debts.
  2. Supplier Relationships: Timely payment of AP ensures trust and reliability with vendors, potentially leading to discounts or favorable credit terms.
  3. Financial Reporting: Accurate AP records are essential for preparing financial statements, such as the balance sheet and cash flow statement, which stakeholders use to assess a company’s financial position.
  4. Compliance: Proper AP management ensures adherence to tax regulations and prevents legal or financial repercussions from unpaid obligations.

Accounts Payable vs. Accounts Receivable

It’s worth distinguishing AP from Accounts Receivable (AR), as the two are often confused. While AP represents money a company owes, AR represents money owed to the company by its customers for goods or services sold on credit. In essence, AP is a liability, while AR is an asset. Both are integral to the accounting cycle but sit on opposite sides of the balance sheet.

For instance:

  • AP Example: A retailer owes $10,000 to a wholesaler for inventory.
  • AR Example: The same retailer is owed $8,000 by a customer who purchased goods on credit.

Examples of Accounts Payable

Let’s explore some practical examples to illustrate how AP works in different scenarios:

  1. Retail Business
    A clothing store orders 100 shirts from a supplier at $20 each, totaling $2,000. The supplier offers credit terms of “net 60,” meaning the store has 60 days to pay. Upon receiving the shirts, the store records $2,000 in its AP ledger. The liability remains until the store pays the supplier within the 60-day period.
  2. Service-Based Company
    A marketing agency hires a freelance graphic designer for a project costing $1,500, with payment due in 30 days. The agency records this as an AP entry when it receives the invoice from the freelancer. Once the payment is made after 30 days, the AP balance decreases by $1,500.
  3. Manufacturing Firm
    A factory purchases $50,000 worth of raw materials on credit to produce goods. The supplier’s terms are “2/10, net 30,” meaning the factory can take a 2% discount ($1,000) if it pays within 10 days, or the full amount is due in 30 days. The initial AP recorded is $50,000, adjusted based on when and how the payment is made.
  4. Utility Bills
    A small business receives a $300 electricity bill with a due date in 15 days. Until the bill is paid, it is recorded as part of the company’s AP.

These examples demonstrate that AP can arise from various transactions, including inventory purchases, services, and operational expenses.

The Accounts Payable Process

The AP process involves several steps to ensure accuracy and efficiency:

  1. Purchase Order (PO): The process often begins with a purchase order issued by the company to the supplier, detailing the goods or services requested.
  2. Receiving Goods/Services: Once the goods are delivered or services are rendered, the company verifies that the shipment matches the PO.
  3. Invoice Receipt: The supplier sends an invoice specifying the amount owed, due date, and payment terms.
  4. Invoice Verification: The AP department checks the invoice against the PO and delivery receipt to confirm accuracy (a process called three-way matching).
  5. Recording AP: The approved invoice is entered into the accounting system as a liability.
  6. Payment: The company schedules and executes payment within the agreed terms, reducing the AP balance.
  7. Reconciliation: The AP ledger is periodically reviewed to ensure all entries align with payments and outstanding obligations.

Automation tools and accounting software, such as QuickBooks or SAP, streamline this process for businesses of all sizes.

How to Record Accounts Payable in Accounting

Recording AP follows the principles of double-entry bookkeeping, where every transaction affects at least two accounts: one is debited, and another is credited. AP is typically recorded when an invoice is received, not when payment is made, aligning with the accrual basis of accounting.

Here’s a step-by-step guide to recording AP, with examples:

1. Initial Recording of AP

When a company receives an invoice for goods or services purchased on credit, it records the expense or asset acquired and the corresponding liability in AP.

Example:
A bakery orders $1,000 worth of flour from a supplier with payment due in 30 days.

  • Debit: Inventory (Asset) $1,000
  • Credit: Accounts Payable (Liability) $1,000

Journal Entry:

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Date: April 07, 2025 Debit: Inventory $1,000 Credit: Accounts Payable $1,000 Description: Purchase of flour on credit, terms net 30.

The debit to Inventory reflects the addition of flour to the bakery’s stock, while the credit to AP represents the obligation to pay the supplier later.

2. Payment of AP

When the company pays the invoice, it reduces the AP balance and decreases its cash.

Example:
On May 07, 2025, the bakery pays the $1,000 owed to the supplier.

  • Debit: Accounts Payable $1,000
  • Credit: Cash (Asset) $1,000

Journal Entry:

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Date: May 07, 2025 Debit: Accounts Payable $1,000 Credit: Cash $1,000 Description: Payment of invoice for flour purchase.

The AP account is cleared, and the cash account decreases by the payment amount.

3. Discounts for Early Payment

If a supplier offers a discount for early payment, the transaction is adjusted accordingly.

Example:
A construction company buys $10,000 of lumber with terms “2/10, net 30.” It pays within 10 days, earning a 2% discount ($200).

  • Initial Entry (upon receiving lumber):
    • Debit: Inventory $10,000
    • Credit: Accounts Payable $10,000
  • Payment Entry (within 10 days):
    • Debit: Accounts Payable $10,000
    • Credit: Cash $9,800
    • Credit: Purchase Discounts (Revenue) $200

Journal Entry:

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Date: April 17, 2025 Debit: Accounts Payable $10,000 Credit: Cash $9,800 Credit: Purchase Discounts $200 Description: Payment of lumber invoice with 2% discount.

The discount reduces the cash outflow and is recorded as a gain.

4. Partial Payments

If a company pays part of an invoice, AP is reduced by the payment amount, leaving the remaining balance.

Example:
A retailer owes $5,000 for merchandise and pays $3,000, leaving $2,000 outstanding.

  • Debit: Accounts Payable $3,000
  • Credit: Cash $3,000

Journal Entry:

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Date: April 15, 2025 Debit: Accounts Payable $3,000 Credit: Cash $3,000 Description: Partial payment of merchandise invoice.

The AP balance drops to $2,000, which will be settled later.

Common AP Challenges and Solutions

  1. Late Payments: Missing payment deadlines can strain supplier relationships or incur penalties.
    • Solution: Use AP automation to schedule payments and send reminders.
  2. Invoice Errors: Discrepancies between invoices and POs can delay processing.
    • Solution: Implement three-way matching to verify details before recording.
  3. Fraud: Duplicate invoices or fake vendors can lead to financial losses.
    • Solution: Establish internal controls, such as requiring multiple approvals for payments.
  4. Cash Flow Strain: High AP balances can tie up funds needed elsewhere.
    • Solution: Negotiate longer payment terms or prioritize payments strategically.

Tools for Managing Accounts Payable

Modern businesses rely on technology to manage AP efficiently:

  • QuickBooks: Ideal for small businesses, offering invoice tracking and payment scheduling.
  • SAP: Suited for large enterprises with complex AP needs.
  • Bill.com: A cloud-based solution for automating payments and approvals.
  • Excel: A manual option for startups, though prone to errors as volume grows.

Conclusion

Accounts Payable is more than just a record of debts—it’s a vital part of financial management that impacts cash flow, supplier relationships, and overall business success. By understanding how AP works, recognizing its importance, and mastering how to record it, businesses can maintain accurate books and make informed financial decisions. From the bakery buying flour to the manufacturer securing raw materials, AP is a universal process that keeps commerce moving.

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