Is accounts payable a permanent account?
Is accounts payable a permanent account? Accounts payable (AP) is the short-term obligations listed on the balance sheet which have been incurred by a company during its operations. It is a current liability that remains due and must be paid in the short term such as legal fees, supplier invoices, contractor payments, etc.
AP is an accounting term that is used to represent the money that the company owes vendors or suppliers for the goods or services purchased on credit. The sum of all the outstanding payments owed by a company to its suppliers is recorded as the balance of accounts payable on the company’s balance sheet. While the increase or decrease in total accounts payable from the prior period will appear on the cash flow statement.
Since this account is recorded as a liability on the balance sheet, is accounts payable a permanent account or a temporary account? In this article, we will discuss whether accounts payable is a permanent account or a temporary account.
Related: Is Prepaid Rent a Permanent Account?
What is accounts payable?
Accounts payable at the corporate level, are short-term payments that are due to suppliers, essentially a short-term IOU from one business to another business or entity. The business that is being owed a certain amount of money would record the transaction as an increase to its accounts receivable while the business that is owing will record the same amount as an increase to its accounts payable account.
Accounts payable is an important figure in the balance sheet of a company. If the AP of a company increases over a prior period, it means that, rather than paying cash, the company is buying more goods or services on credit. Conversely, if a company’s AP decreases, it is an indication that the company is paying its prior period obligations at a faster rate than it is purchasing goods or services on credit. Therefore, AP management is important in managing a business’s cash flow.
When preparing the cash flow statement with the indirect method, the net increase or decrease in AP from the prior period appears in the top section, which is the cash flow from operating activities. Management can use accounts payable to manipulate the company’s cash flow to a certain extent.
For instance, management can increase cash reserves for a certain period by extending the time the business takes to pay all outstanding accounts in accounts payable. Nevertheless, this flexibility to pay later must be weighed against the ongoing relationships that the company has with its vendors; as it is a good business practice to always pay bills by their due dates.
Recording accounts payable
When carrying out proper double-entry bookkeeping, it is required that there must always be an offsetting debit and credit for all entries made into the general ledger. Therefore, in order to record accounts payable when the bill or invoice is received, the accountant credits accounts payable. Then, the offsetting debit entry for this transaction would generally go to an expense account for the good or service that was purchased on credit. The journal entry for this would be:
| Accounts | Debit | Credit |
|---|---|---|
| Expense A/c | $0 | |
| Accounts payable A/c | $0 |
Also, the offsetting debit entry for accounts payable could be to an asset account if the item that was purchased is a capitalizable asset. That is, the journal entry for this would be:
| Accounts | Debit | Credit |
|---|---|---|
| Asset A/c | $0 | |
| Accounts payable A/c | $0 |
However, when the bill is eventually paid, the accountant would have to debit accounts payable to decrease the liability balance and the offsetting entry will be a credit to the cash account, which also decreases the cash balance. The journal entry for this will be:
| Accounts | Debit | Credit |
|---|---|---|
| Accounts payable A/c | $0 | |
| Cash A/c | $0 |
See also: Unearned revenue is what type of account?
What is a permanent account?
Permanent accounts are accounts such as asset, liability, and equity accounts that continue to maintain ongoing balances over time. Unlike temporary accounts, these accounts are not closed at the end of the accounting period and are therefore aggregated into the balance sheets. Temporary accounts, on the other hand, begin each fiscal year with a zero balance and at the end of the year, the ending balance is shifted to a different account. This process of shifting the balances of a temporary account to a different account (retained earnings account) is known as closing an account.
At the end of every accounting period, accountants record closing entries. They make closing entries to reset temporary accounts to a zero balance. These closing entries would transfer the revenues and expenses that the company has incurred during the period to the equity section of the balance sheet. For accounts payable, no closing entries are recorded, though the accounts payable function happens to affect the closing expense entries. Since no closing entries are recorded for accounts payable, it is a permanent account and not a temporary account.
Permanent accounts are measured cumulatively and are reported on the balance sheet. Therefore, all asset accounts, liability accounts, and capital (equity) accounts are permanent accounts. Permanent accounts include- Asset accounts such as Prepaid Expenses, Accounts Receivable, Cash, Inventories, Equipment etc, as well as contra-asset accounts like Allowance for Bad Debts and Accumulated Depreciation; Liability accounts such as Accounts Payable, Notes Payable, Interest Payable, Loans Payable, Rent Payable, etc; Equity accounts such as reserve accounts, capital stock, and retained earnings in corporations as well as owner’s capital accounts and partners’ capital accounts.
Temporary accounts, on the other hand, include revenue accounts, expense accounts, gain and loss, and the income summary account. They include accounts such as sales revenue, service revenue, cost of goods sold, sales discounts, sales return and allowance, compensation expense, supplies expense accounts, loss on assets sold account etc. They are used to compile transactions that impact the profit or loss of a business during a year and are aggregated into the income statement.
Related: Is Cost of Goods Sold a Debit or Credit? (COGS)
Is accounts payable a permanent account?
All the accounts reported on the income statement are temporary accounts while the accounts reported on the balance sheet are permanent accounts. Note that accounts payable are not treated as expenses on the income statement. Hence, it is not a temporary account. Some people mistakenly believe that accounts payable refer to the routine expenses of a company’s main operations. That is an incorrect interpretation of accounts payable.
Accounts payable are the short-term debts that a company owes its creditors or suppliers which are booked on the balance sheet as a liability, whereas expenses are the cost incurred and money spent by the company in pursuing revenue, which is found on the company’s income statement.
At the end of every accounting period, accountants record closing entries that would transfer the revenues and expenses that the company has incurred during the period to the equity section of the balance sheet in order to reset the revenues and expenses accounts to a zero balance. For accounts payable no closing entries are recorded. Therefore, accounts payable like other permanent accounts are not closed at the end of the accounting period, rather, they continue to maintain ongoing balances over time. Hence, accounts payable is a permanent account.
Permanent accounts such as asset, liability, and equity accounts are reported on the balance sheet while temporary accounts are reported on the income statement. Accounts payable is a liability because it is money owed to one or many creditors and as such is shown on a business’s balance sheet. Therefore, accounts payable being reported on the balance sheet makes it a permanent account and not a temporary account.
See also: Is Sales Discount Debit or Credit?
