The A/P Difference

One option in working with the Payables account is to understand the process. The other option is to risk getting tangled up like a kitten in a ball of yarn. QuickBooks correctly accounts for purchases, whether by cash or on open account. Buying now and paying later are handled well, but this option is not free. You pay the price of handling a more complex system.

Buying on account is, on the surface, quite different from paying cash. Inside an accrual method accounting system, the two actions are rather similar. Understanding these similarities is essential to being comfortable in the use of accounts payable.

Some examples serve to make this clear. One purchase of a capital asset is reviewed, and one purchase of an expense item. These purchases are discussed once as bought for cash, and then as bought on account.

When each cash purchase is made, an asset decreases. If there is a corresponding increase in another asset, net worth remains the same. In an expense purchase, there is no corresponding asset increase, so net worth decreases. Whether expense or capital purchase, the first action is to decrease the asset.

Marine Marvels buys a whale. Since the XE "investment" animal is expected to be present and useful for many years, accounting sees it as an asset. Hopefully, this beast will also prove an asset in the theatrical sense.

However, this is a totally unethical orca, who performs only when bribed with fresh fish. Money goes out for the purchase of fish. This commodity is perishable, and useful only if consumed in a few days, so accounting calls it an expense. The money asset decreases, but there is no corresponding increase in any other asset, so net worth decreases. Presumably, the whale will be trained, and the performances will draw audience revenue, to produce a net profit. That is beside the point. The purchase of the fish is good business, but it remains an expense.

Now consider these transactions, using payables. Forgetting reality, assume that some source is willing to capture whales, and sell them on account. Marine Marvels buys a whale by assuming a debt, recorded in Accounts Payable. A liability increases, but an asset has increased. As with the cash purchase, net worth does not change.

More realistically, the fish is purchased on account. A liability increases, with no increase in an asset. Net worth decreases, just as with the cash purchase.

At some future date, the debts will be paid off. Cash will decrease, and the liabilities will decrease by the same amount, and net worth does not change. Note that paying off the debts is not at all connected to the expenses. Accrual method accounting now sees them as past history.

Internally to the accounting, the payables transactions are quite similar to the cash transactions. The difference is the date when the cash goes out, and that is the big difference. Instead of using your own money, you are using someone else’s working capital. One price of this privilege is the matter of tracking the purchases through payables. QuickBooks is adept at this, but no program is omniscient. It is much more useful when you have a clear grasp of the whale process -- oops, the whole process.