What is the Accounting Treatment of Accounts Payables?

Meaning and Definition of Accounts Payables
Before immersing ourselves into providing answer to the question of what is the accounting treatment of accounts payables, it will be cool if we first of all attempt to establish a working understanding of what accounts payables really is. So, let us spend the next few minutes providing a simple explanation.

Accounts payable (AP) is a liability account in a company’s general ledger that represents the amount of money a business owes to its suppliers and creditors for goods and services that have been received but not yet paid for. This is the direct opposite of accounts receivables.

Put differently, accounts payable represents the company’s short-term debts or obligations to pay for goods or services that have already been delivered or performed.

Simple practical illustration of accounts payables (accounts payable cycle)

1. Purchase of Goods or Services: A company purchases goods or services from its suppliers or vendors on credit terms or enters into a valid contract for the purchase of goods & services on credit. These credit terms specify when payment is due, which is often within a specific time frame, such as 30 days from the date of the invoice.
2. Invoice Received: The supplier or vendor sends an invoice to the company, detailing the products or services provided, their costs, and the payment terms.
3. Transaction is Journalized or Recorded: The company records the invoice in its accounting system as an account payable, recognizing the amount it owes to the supplier. Please read up my previous article on journal entry for clearer understanding of how it works. This creates a liability on the company’s balance sheet.
4. Time to Make Payment: When the payment becomes due, the company issues a payment to the supplier, reducing the accounts payable balance.

Accounts payable is an important part of a company’s working capital management. The benefits that comes from managing accounts payable effectively is enormous including helping a company maintain good relationships with its suppliers, take advantage of trade credit terms, and ensure that it meets its financial obligations in a timely manner. Simply put, the roles of accounts payables in working capital management cannot easily be overlooked by serious businesses.

On the side of being compliant as a business, accounts payable is an indispensable part of a company’s final accounts, as accounts payable is reported on a company’s statement of financial position (balance sheet) as a current liability.

Under International Financial Reporting Standards (IFRS), the accounting treatment for accounts payable is generally consistent with the accounting principle of accrual accounting. IFRS provides guidelines on how to recognize, measure, and present accounts payable in a company’s financial statements.

Accounting treatment of accounts payable is treated under IFRS

This section of this article on what is accounts payables provides a condensed version of the provisions of IFRS as it relates to accounts payables.

Recognition: Accounts payable are recognized when an entity has received goods or services from a supplier (usually evidenced by an invoice) and has an obligation (performance obligation) to make a payment for those goods or services in the future. That is to say, it is only recognized when there is a legal or constructive obligation to pay – anything else falls under creative accounting and fraudulent accounting, period!

Measurement: Accounts payable are initially measured at the fair value of the agreed consideration. This typically represents the invoiced amount net of any trade discounts, rebates, or allowances as long as they are offered as part of the purchase agreement.

Subsequent Measurement: After initial recognition, accounts payable are measured at amortized cost. The amortized cost is generally the initial measurement amount minus any payments made and adjusted for any applicable interest or finance charges.

Presentation: Accounts payable are presented on the statement of financial position as a current liability, typically under the heading “Trade and Other Payables.” If the payment is not expected to be made within 12 months after the reporting period (i.e., it’s a long-term liability), it should be classified as a non-current liability.

Disclosures: Companies are required to disclose the carrying amount of accounts payable, the terms and conditions of outstanding payables, any guarantees related to those payables, and any significant accounting policies related to accounts payable in their financial statements.

Currency (FOREX) Considerations: If accounts payable are denominated in a foreign currency, they should be translated into the functional currency of the reporting entity using the exchange rate at the date of the initial recognition. Exchange rate differences may be recognized in profit or loss for the period.

It is important to note that IFRS is a principles-based accounting framework, and while it provides guidelines on the treatment of accounts payable, the specific accounting treatment may vary based on the unique circumstances and transactions of a company. Therefore, companies often work with professional accountants or auditors to ensure compliance with IFRS reporting standards.

Accounting treatment of accounts payable is treated under US GAAP

Under the US Generally Accepted Accounting Principles (GAAP), the treatment of accounts payable is similar to that of IFRS in many ways.

However, there may be some differences in terminology and specific accounting guidance. Below is the details of how accounts payable are treated under US GAAP:

Recognition: Similar to IFRS, accounts payable under U.S. GAAP are recognized when an entity has received goods or services from a supplier and has an obligation to make a payment for those goods or services. This obligation is typically evidenced by an invoice.

Measurement: Accounts payable are initially measured at the invoice amount, which is typically considered to be the fair value of the liability. Any trade discounts, rebates, or allowances are netted against the initial measurement if they are offered as part of the purchase agreement.

Subsequent Measurement: After initial recognition, accounts payable are measured at their face value (the invoiced amount) minus any payments made. Interest or finance charges related to accounts payable are generally not included unless they are significant and separately negotiated.

Presentation: Similar to IFRS, accounts payable are presented on the balance sheet as a current liability. They are typically included under the heading “Accounts Payable” or “Trade Payables.”

Disclosures: Companies following US GAAP are required to disclose information about their accounts payable, including the carrying amount, terms and conditions of outstanding payables, and any significant accounting policies related to accounts payable. Additionally, companies may need to disclose any guarantees related to these payables.

FOREX Considerations: If accounts payable are denominated in a foreign currency, US GAAP generally requires the use of the current exchange rate at the balance sheet date for translation. Exchange rate differences may be recognized in income, depending on the circumstances.

It’s important to note that US GAAP and IFRS have converged on many accounting standards in recent years, aiming to reduce differences between the two frameworks. However, there may still be some subtle differences in the application of these standards in practice. Companies following US GAAP should consult the Financial Accounting Standards Board (FASB) Accounting Standards Codification and work with professional accountants or auditors to ensure compliance with US GAAP reporting requirements

IFRS vs US GAAP on accounts payables

This post will in my opinion be incomplete if a sort of comparison of the position of IFRS and US GAAP on accounts payables is not made. So, let’s compare the accounting treatments of accounts payable under International Financial Reporting Standards (IFRS) and U.S. Generally Accepted Accounting Principles, highlighting the key differences:

1. Recognition:

IFRS: Accounts payable are recognized when there is a legal or constructive obligation to pay for goods or services received. It emphasizes the obligation aspect.

U.S. GAAP: Similar to IFRS, accounts payable are recognized when there is an obligation to pay for goods or services, typically evidenced by an invoice.

2. Measurement:

IFRS: Initially measured at the fair value of the consideration to be paid, which is usually the invoiced amount. Trade discounts and allowances are deducted if applicable.

U.S. GAAP: Initially measured at the invoice amount, which is considered the fair value. Trade discounts, rebates, or allowances are also deducted if part of the purchase agreement.

3. Subsequent Measurement:

IFRS: After initial recognition, accounts payable are measured at amortized cost, which involves adjustments for payments made and any applicable interest or finance charges.

U.S. GAAP: After initial recognition, accounts payable are typically measured at the invoiced amount minus payments made. Interest or finance charges are generally not included unless they are significant and separately negotiated.

4. Presentation:

IFRS: Presented on the balance sheet as a current liability, typically under the heading “Trade and Other Payables.”

U.S. GAAP: Presented on the balance sheet as a current liability, typically under the heading “Accounts Payable” or “Trade Payables.”

5. Disclosures:

IFRS: Requires disclosure of the carrying amount of accounts payable, terms and conditions of outstanding payables, any guarantees related to payables, and significant accounting policies.

U.S. GAAP: Requires disclosure of information about accounts payable, including the carrying amount, terms and conditions of outstanding payables, and significant accounting policies. Disclosure requirements for guarantees may also apply.

6. Currency Considerations:

IFRS: Accounts payable denominated in a foreign currency should be translated into the functional currency using the exchange rate at the date of initial recognition, with exchange rate differences recognized in profit or loss.

U.S. GAAP: Generally follows a similar approach to IFRS for translating foreign currency accounts payable, using the exchange rate at the balance sheet date, with exchange rate differences often recognized in income.

In summary, while there are similarities in the accounting treatment of accounts payable between IFRS and U.S. GAAP, the key differences lie in the terminology used and some nuances in measurement and presentation. Both frameworks focus on recognizing and measuring the obligations related to accounts payable, but the specific guidance may vary slightly especially in the area of accounting year end adjustments.

Companies should carefully consider the applicable accounting standards and consult with professional accountants to ensure compliance. I hope this article has provided you with a reasonable answer to the question of ‘what is the accounting treatment of accounts payables?’