On the income statement, accounts payable are excluded from the calculation of net income or loss since it is a non-operating account.
The income statement is one of the five financial statements that businesses use to present the organization’s finances in a certain period. The other two statements which are yet to be discussed here are the balance sheet and the cash flow statement.
An income statement displays the revenue, expenses, and net income or net loss of the company. It shows how profitable the business was and how the business was run for the period under consideration. Accounts payable is a fixed operating expense that can be reflected in the income statement. But that is a different question and requires an answer to the question: where does it fit in?
Accounts payable commonly known as AP is the total sum that a business owes to its suppliers for products or services that it has borrowed without making cash payments for them immediately. This is classified as an account payable in the balance sheet because it is a short-term financial liability where the business owes money to its vendors, and it is usually due within one year.
When a company purchases inventory, materials, office supplies, or utilizes some utilities or any other service, it is customary that it is offered some trade credit by the suppliers. This provides it adequate time to market the merchandise and earn revenues before it is due to meet the bills. It is recorded in the account entitled accounts payable as the amount owed is accumulated throughout the credit term.
Suppliers offer credit terms such as Net 30 which indicate that the amount is due within thirty days from the date of the invoice. Other common accounts payable terms are Net 15, Net 45, Net 60, etc. These terms differ in the number of days and companies aim at achieving a balance where accounts payable match accounts receivable terms with their customers. This is all about managing cash flow, for example, this implies paying suppliers on time to have good credit with them.
Therefore, accounts payable liability builds up over time as the money borrowed for purchasing goods or services is not paid back at the same time. This account is shown on the balance sheet, in the current liabilities section, until the invoices have been paid off. Purchases affect the balance sheet, and the payment of accounts payable impacts the income statement.
While accounts payable is a liability that is expected to be paid in the future, it is an act of expending on inventory and services. The amount owed to suppliers is both:
1. Balance Sheet Liability - The Credit – The commitment to pay for goods and services availed on credit within a short time.
2. Accounting Profit & Loss Statement Line – Cost of other income-generating and operating activities.
Now again, I know that this accounts payable expense does not appear on the profit and loss statement instantly, so when does it appear? Here's how it works...
The income statement shows all the revenue and expenses occurring in the period, even if the business has not yet been paid for the product or paid its suppliers. Accounts payable expense is recorded at the time of:
1. Receiving Inventory – When it comes to the cost of the inventory that is received, it will enable matching of the cost against revenues it will help create.
2. Current Operations – Services consumed in the ongoing operation, such as utilities, maintenance, services, etc.
While there is no actual cash outflow in the form of supplier invoices for such invoices, the amount is realized once one needs to buy goods & services in the current period.
As a result, the income statement includes accounts payable expense as part of:
- COGS - The raw materials and merchandise for products manufactured/sold.
- Wages and Salaries – All employee expenses including administration, management, etc.
This is because by identifying such expenses during the period, the income statement provides a real representation of the business’s profit for the fiscal period. This does not only encompass the total cash that is paid or received during the period. The payable amount to the suppliers is then transferred to the balance sheet as another current liability.
For instance, if a retailer having $5,000 worth of goods in stock during December bought them on credit and has not yet paid for the goods, then $5,000 of the cost of goods sold expense is included in the income statement and reduces the gross profit for December. On the other hand, the $5,000 Accounts Payable) is shown as an obligation on the balance sheet as of December 31.
This is because when the payment is finally made next month it decreases the account payable on the balance sheet. The inventory was recognized as to expense when it was taken in December through the income statement.
On the income statement, therefore, accounts payable are not listed separately on the list of current assets. The amounts owed to suppliers are embedded within the relevant expense categories over the period:
- Cost of Goods Sold – Provides details on expenses that are directly related to the cost of goods and those related to the sales of the unit.
- Operating Expenses – General and Administrative expenses or cost of operations/CPM costs.
- Other Expenses – Small and incidental expenses such as interest on borrowed money
The final accounts may contain the total accounts payable balance that may be owed as per the footnotes. However, accounts payable are only reflected as expenses on the income statement not as a separate and separate expense but as subcategories of other expenses.
On the balance sheet, accounts payable has its place under the current liability section labeled “Accounts Payable”. The balance sheet provides a picture of the accounts payable for the supplies received during the last day of each accounting period.
The statement of cash flow indicates the amount of money that has been paid to the suppliers to clear the amount in the accounts payable account which is a liability. This aspect of accounts payable is also affected by the difference in balance sheet dates because it is also a part of cash from operations.
Getting a good grasp of accounts payable is important for both external and internal financial statement users:
- Analysts and portfolio managers – evaluate how much the company is earning and its capacity to repay its debts.
- Creditors – Assess the ability to afford credit and the ability of the borrower to repay.
- Management – Citizenship expenses and cash flow trends
By the same token, accounts payable, though not directly reflected in the income statement, are involved in the evaluation of profitability. Items such as inventory, services, and operating overhead that were used up in a particular period directly impact the bottom line regardless of whether payment has been received or not.
Accounting for the accounts payable also helps in avoiding expenses such as late payment penalties or even the lack of supplies due to poor relations with the suppliers. The accounts payable streamline the process of revenue and expense recognition, which gives a coherent view of the company's performance in the financial statements.
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