When a business purchases some asset or incurs expenses and agrees to make payment after some time, there is a need to record liability as a business has already obtained economic benefit. To record a liability, we need to pass an entry in the accounting system called a journal entry.
An increase in liability is credited to the accounts payable account, and expenses/assets are debited in their respective chart of accounts.
The credit side or liability is reported under the current liability section of the balance sheet, and the debit side may be shown in the balance sheet if it’s a purchase of the asset or recorded in the income statement if the transaction is related to expenses incurred by the business.
The amount to be posted for recording payable is obtained from the supplier’s invoice as it’s considered to be a source document and contains all the details about the quantity, price, and terms of the purchase transaction.
The balance of accounts payable in the liability section is reversed when payment is made to the supplier. Once payment is made to the supplier, the net accounting entry increases the assets/expenses and decreases the cash.
Let’s discuss some of the typical journal entries related to accounts payable, which are frequently used to manage the accounts payable function.
Journal entry for purchase of the merchandise inventory
When the company purchases the merchandise inventory on credit, the journal entry to be posted can be different depending on the inventory policy adopted by the company.
If the company uses periodic inventory accounting, merchandise increases will be debited in the “purchase A/C,” and the following journal entry will be posted.
| Particulars | Debit | Credit |
| Purchase A/C | X,XXX | |
| Accounts payable A/C | X,XXX |
In the periodic inventory policy, inventory is updated after each period, and consumption is calculated to be charged in the financial statement at the end of the period.
On the other hand, if the company adopts a perpetual inventory accounting system, Purchase A/C will be replaced with the inventory account, and the following entry will be posted in the accounting system.
| Particulars | Debit | Credit |
| Inventory A/C | X,XXX | |
| Accounts payable A/C | X,XXX |
In this type of inventory policy, inventory is updated on each purchase and sale transaction. On purchase of the goods, inventory is debited, and on sale of the inventory is credited. The amount of consumption can be obtained at any time because the system is updated in real-time.
Journal entry for return of the faulty merchandise inventory
If the goods received by the company are faulty and there is a need to return them, an accounting system can be updated with the following journal entry.
| Particulars | Debit | Credit |
| Accounts payable A/C | X,XXX | |
| Inventory A/C / Purchase A/C | X,XXX |
This entry removes inventory/purchase from the accounting system and decreases liability from the books of accounts. It’s important to note that we only need to record this entry to the extent of faulty goods returned.
Journal entry for purchase of the property, plant, and equipment
When the company purchases fixed assets on account, the purchased asset is debited, and accounts payable are credited. The following entry is posted in the accounting system to record the transaction.
| Particulars | Debit | Credit |
| Property, plant, and equipment A/C | X,XXX | |
| Accounts payable A/C | X,XXX |
It’s important to note that if the company purchases assets in cash, there is no accounting need to record journal entries, but a payment voucher is created, and cash is paid.
Yet, some companies first post a journal entry to increase the span of control on the purchase transaction.
Example of a posting journal entry in accounts payable (Expense transaction)
Consider a company that makes a purchase of office supplies on account amounting to $600. The amount is payable after 90 days.
Since an amount is payable within a time of one year, it means it’s a current liability. The journal entry for the given transaction can be posted as follows.
| Particulars | Debit | Credit |
| Supplies expenses A/C | $600 | |
| Accounts payable A/C | $600 |
Example of a posting journal entry in accounts payable (Asset transaction)
Consider a company purchasing a vehicle on an account; the value of the purchased vehicle amounts to $35,000. The amount is payable after six months.
Since an amount is payable within a period of 12 months, this balance is shown as a current liability in the balance sheet. The journal entry for the transaction can be posted in the payable ledger as follows.
| Particulars | Debit | Credit |
| Vehicle (PPE) A/C | $35,000 | |
| Accounts payable A/C | $35,000 |
After six months, when the business makes a payment, liability is reversed, and the amount is paid. The following transaction can be posted in the books of accounts for removing liability from the books of accounts.
| Particulars | Debit | Credit |
| Accounts payable A/C | $35,000 | |
| Cash and bank balance A/C | $35,000 |
In the first entry, liability was credited, which means there was an increase in liability. In the second entry, when the payment has been made, there is a debit of the liability. Hence, liability was credited for some specific period and removed when payment has been made.
So, the net impact of both transactions is an increase in capital assets and a decrease in the cash from the bank account.
Difference between accounts payable and trade payable
Some people interchange the terms accounts payable and trade payable. However, both the terms are different and have a slight difference in their interpretation.
Accounts payable is a general term that includes all the payable balances, including payable balances due to litigation, trade payable, payable balances arising due to operating expenses, and other payables.
On the other hand, trade payable balance only contains balances payable to vendors and suppliers of the company. These are the vendors that supply raw materials and other parts used in the production of the company.
For instance, payable trade balances of the juice manufacturing company contain balances payable to the fruit sellers.
Why journal entry is a favorite area of auditors?
The journal entry is critical in the accounting system because it has a direct impact on the profit of the company.
Further, it does not need any movement of cash for posting the entry in the accounting system. Hence, it can be an area where management can play with figures and modify profits to their desires.
So, auditors develop some specific audit programs to ensure journal entries do not have an element of material misstatement whether intentional or unintentional.
Frequently asked questions
What’s the impact of accounts payable on the income statement of the company?
If there is an overstatement of liability in the financial statement, the profit is understated. On the other hand, if there is an understatement of the liability in the financial statement, the figure of the profit is overstated.
What is a payable ledger?
It’s a subsidiary ledger of a general ledger that contains details for all of the balances payable to each vendor/supplier along with their history of transactions.
What is a three-way match for posting transactions in the payable ledger?
A three-way match refers to a comparison of details on three documents. These documents include purchase orders, goods dispatched notes, and invoices. This comparison is considered strong internal control and helps to ensure the accuracy of the payable management system.
What is GRN, and what’s its role in posting for the accounts payable?
GRN – Goods Received Note is a document prepared by the company to record details for the receipt of the goods. It’s an internal document prepared by the company and is considered one of the essential documents in purchase management.
Comparison of GRN with the invoice helps to ensure the supplier has sent the bill for the goods that have been delivered in actuality. It helps to ensure that there is no overbilling and that the company pays for the goods it has received in actuality.
Why is payable balance considered to be important in financial analysis?
Payable balance is considered to be one of the essential balances in financial analysis. This is due to the fact that if the accounts payable balance keeps increasing from period to period, it signals to investors that the company may be facing some problems in managing the payment of the liability to the vendors and other parties.
Further, a higher balance of the accounts payable leads to an adverse impact on the current ratio, which is considered one of the most important liquidity measures.
