COLLEGE OF BUSINESS AND ACCOUNTANCY
Topic: Accounts Payable
Learning Objectives:
1. Know the recognition criteria and nature of accounts payable
2. Know the initial and subsequent measurements of accounts payable
Core Value/Biblical Principles:
We must recognize and acknowledge God as the real source of all good gifts upholding his compassion, grace,
patience, love, faithfulness, forgiveness and justice; and not bringing dishonor to his name in our words or
actions; nor should we seek glory for ourselves.
Introduction:
Accounts payable are obligations that must be paid off within a given period to avoid default. At the corporate
level, AP refers to short-term payments due to suppliers.
AP is an important figure in a company's balance sheet. If AP increases over a prior period, that means the
company is buying more goods or services on credit, rather than paying cash. If a company's AP decreases, it
means the company is paying on its prior period obligations at a faster rate than it is purchasing new items on
credit. Accounts payable management is critical in managing a business's cash flow.
Body:
Definition of Accounts Payable
These are liabilities arising from purchase of goods, materials, supplies, or services to be used in the normal
operating cycle of an entity on an account basis or obligation not supported by formal promises to pay. They
are also known as trade accounts payable.
Recognition of Accounts Payable
Entities usually recognize accounts payable in the books when the goods are received or when the invoices are
received by the supplier.
However, an entity shall recognize accounts payable when it acquired control over the goods because, in effect,
that is the date when the entity becomes a party to the financial instrument
Measurement of Accounts Payable
- At fair value
Accounting for Discounts
• Trade discounts
o These are given to customers to encourage them to buy in bulk or large quantities
o Known as quantity discounts
o They are deducted from the list price to arrive at invoice price
o These are not recognized for financial reporting purposes
• Cash discounts
o These are given to credit customers to encourage them to pay their dues early
o Known as early payments discount
Methods of Accounting for Cash Discounts
• Gross method
o Purchases and accounts payable are recorded at gross invoice amount, meaning the cash
discount is not yet deducted from the invoice amount
o Cash discounts are recognized only when actually taken by the company
o The most common and widely used method because it is simple to apply
o If a credit purchase is still unpaid as of the end of the reporting period and is still within the
discount period, an adjusting entry is made to recognize the purchase discount related to that
purchase
▪ No adjusting entry is required when the outstanding account is already outside the
discount period as of the end of the reporting period
• Net Method
o Purchases and accounts payable are recorded at an amount net of the highest cash discount
offered by the supplier
o Cash discounts not taken by the company are debited to the purchase discounts lost account,
which is classified as finance cost (or interest expense) in the statement of comprehensive
income
o If a credit purchase is still unpaid as of the end of the reporting period and is already outside
the discount period, an adjusting entry is made to recognize the purchase discounts lost by
debiting purchase discounts lost and crediting accounts payable
▪ No adjusting entry is required when the outstanding account is still within the
discount period as of the end of the reporting period
Journal entries:
GROSS METHOD NET METHOD
To record the purchase on account
Purchases* xxx
Purchases xxx Accounts Payable* xxx
Accounts Payable xxx
*Net of the highest cash discount offered
To record the return of defective goods to the supplier
Accounts Payable xxx
Accounts Payable xxx Purchase Return and Allowances* xxx
Purchase Return and Allowances xxx
*Net of the highest cash discount offered
The company paid within the discount period
Accounts Payable xxx
Accounts Payable xxx
Purchase Discounts xxx
Cash xxx
Cash xxx
The company paid outside the discount period
Accounts Payable xxx
Accounts Payable xxx
Purchase Discount Lost xxx
Cash xxx
Cash xxx
Effect of freight charges on Accounts Payable
When the merchandise is shipped by a common carrier, the carrier prepares a freight bill in accordance with
the instructions of the party making the shipping arrangements. The freight bill designates which party
shoulders the cost, and whether the shipment is freight prepaid or freight collect
• FOB Shipping Point
o The buyer shoulders the shipping cost
o Ownership over the goods passes from seller to the buyer when the inventory leaves the
seller’s place of business – shipping point
• FOB Destination
o Seller bears the shipping cost
o Title passes only when the goods are received by the buyer at the point od destination
• Freight Prepaid
o The seller pays the transportation costs before shipping the goods sold
• Freight Collect
o The freight entity collects from the buyer
Summary:
Who shoulders the Who pays the
Freight Terms
transportation cost? transportation cost?
FOB Destination, Freight Prepaid Seller Seller
FOB Shipping Point, Freight Collect Buyer Buyer
FOB Destination, Freight Collect Seller Buyer
FOB Shipping Point, Freight Prepaid Buyer Seller
Supplier’s Debit Balance
These are the debit balances in accounts payable resulting from overpayments, return and allowances, and
advance payments to suppliers. They are classified as current asset unless the amount is immaterial in which
case an offset may be made against the accounts payable account
Adjusting entry:
Suppliers’ debit balances / Advances to suppliers xxx
Accounts Payable xxs
Financial Statement Presentation
Trade accounts payable are presented in the current liabilities section of the statement of financial position
under the heading “Trade and Other Payables”
References:
Understanding Accounts Payable (AP) With Examples and How to Record AP (investopedia.com)
Basic Accounting by Win Ballada, CPA, CBE, MBA
