Accrued Expenses vs Accounts Payable: How Are They Different?
Ira Brooker June 14th, 2021 Updated: February 7th, 2023
AP management is often a field defined by subtle distinctions. When it comes to managing payments, one of the key distinctions is the difference between accrued expenses and accounts payable. While these concepts are similar and closely related, understanding the differences between the two is essential for making sure your organization’s expenses are paid for efficiently and accurately.
Let’s explore what we mean when we talk about accrued expenses and accounts payable, including their differences and similarities and some useful examples of each.
TABLE OF CONTENTS
- Key Differences Between Accrued Expenses and Accounts Payable
- What Are Accrued Expenses? – Definition and Examples
- What Is Accounts Payable? – Definition and Examples
- How to Classify Current Liabilities as Accounts Payable or Accrued Expenses
- What’s the Difference Between Accounts Payable and Accrued Expenses?
- How Can Automation Change the Future of Your Accounts Payable and Accrued Expenses Management?
AN ACCRUED EXPENSE
- Is owed by your organization but does not yet have a bill or invoice attached
- Applies to goods and services that your organization has already received but not yet paid for
- Often includes a specific window for payment as spelled out by a contract or company policy
AN ACCOUNTS PAYABLE EXPENSE
- Has been billed or invoiced for but not yet paid for
- Includes any purchases made on credit
- Often has a more flexible window for payment, with discounts available for early payment
“Simply put, automation is the key to an agile and scalable AP operation. As technology advances, finance leadership will further understand the importance of investing in a solution that allows their AP team to go from transactional to strategic.”
What Are Accrued Expenses?
Before we can get into describing the differences between accrued expenses and accounts payable, we’ll need to start with the basics of how each is defined—and how you should log them in your accounting ledger.
Accrued expenses are incoming expenses that have not yet been billed or invoiced, but the services have already been delivered. The purpose of accrued expense entries is to help keep track of debts as soon as the goods or services are delivered. These debts accrue—or build up—over time, and are a current liability for the company. Typically, accrued expenses are due within a year, at most, of the transaction date.
However, without an invoice immediately available, the exact amount due for certain accrued expenses may not be known. When this is the case, it’s best practice to log an estimate in your ledger that you’ll update once the invoice arrives.
What Are Some Examples of Accrued Expenses?
Although any expense without a bill or invoice could reasonably be classified as such, accrued expenses are usually short-term liabilities. Exactly what falls under that umbrella will vary widely depending on your industry and your internal accounting practices, but there are a few common types of accrued expenses that are fairly universal. Examples of accrued expenses might include:
- Employee wages and salaries (payroll)
- Employee vacation pay
- Utility, phone and internet bills
- Rent and mortgage payments
- Reimbursement for employee travel expenses
- Any goods and services delivered, but not yet billed, during the accounting period
What Is Accounts Payable?
Accounts payable entries, on the other hand, are records of expenses that have already been billed or invoiced, including anything bought on credit. These debts will be paid within one year at the most. (As such, they’re considered short-term or current liabilities.)
The main purpose of an accounts payable entry is to document payments that will be issued in the near future, in order to ensure third parties are paid on time and that bills are paid only once. This tracking of near-term expenses is a critical component of assessing an organization’s financial health.
In addition to avoiding redundant or missed payments, and their subsequent late fees, a well-run accounts payable department helps businesses secure early payment discounts—all of which helps bolster a company’s financial health and ensures that its cash flow is in order.
What Are Some Examples of Accounts Payable Expenses?
Again, the expenses that fall into the accounts payable category will vary from organization to organization, but there are some purchases that are fairly universal. Some of the most common examples of accounts payable expenses include:
- Direct labor costs
- Transportation of goods and services
- Purchases of raw materials
- Purchases of technology and equipment
- Leases for business spaces
- Energy and power bills
- Third-party services such as subcontractors
How to Classify Current Liabilities as Accounts Payable or Accrued Expenses
A current liability is generally defined as a debt that an organization must pay within 12 months or less. Knowing how to properly classify current liabilities as either accounts payable or accrued expenses is a necessary step for projecting an organization’s overall expenses and net income for a particular time frame. Let’s look at some of the factors that decide how those expenses should be categorized.
Accounts Payable as a Current Liability
In most cases, goods or services that an organization obtains from a vendor or supplier are not expected to be paid for immediately. Depending on vendor preferences and requirements, those payments are usually due anywhere from 14 to 90 days from the time of purchase. During that grace period, accounts payable expenses are classified as a current liability. That designation simply means that a business is obligated to pay its accounts payable expenses within the specified payment window.
This is also the period during which some vendors offer discounts for early payments as a way of building stronger business relationships and rewarding customers who pay their bills consistently. Your accounting team may be able to leverage these payment windows and early payment discounts improve liquidity and enhance your organization’s short-term cash flow.
An AP automation solution can help your organization take advantage of those early payment discounts by significantly reducing the time it takes to process payments. Research shows that an automated invoice processing system can cut payment time by more than 50%, giving an organization far more flexibility to pay suppliers quickly and accurately. Your automated system can even provide alerts and notifications when payments are coming due.
Accrued Expenses as a Current Liability
Accrued expenses are also considered current liabilities because your organization is obligated to pay them off in the short term. Specific terms of payment will depend on both parties’ company policies and any agreements or contracts signed, but payment is expected within 12 months or less.
Categorizing accrued expenses as current liabilities can be somewhat complicated because they often include payments whose exact amounts are not yet known. That might include interest payments on loans, whose total amount will depend on how much interest has accumulated when the payment is rendered. Other examples include tax payments and payments rendered for product warranties.
The visibility that comes with an automated AP software system makes managing accrued expenses much easier. Being able to see at a glance which payments are coming due and where each item is in the process at any given time not only allows your AP team to budget more accurately, it also makes it much simpler to make adjustments and correct errors that could otherwise delay payments.
What’s the Difference Between Accounts Payable and Accrued Expenses?
As we mentioned above, accounts payable and accrued expenses are both current liabilities, but accounts payable entries have already been invoiced or billed and payment is due soon whereas accrued expenses have not yet been invoiced or billed and payment will become due in the future.
Because both accounts payable and accrued expenses are critical for a company’s finances, it’s important to understand the differences between the two. Here’s a breakdown of how accounts payable and accrued expenses differ in a few key areas:
Accounts Payable Accrued Expenses
1. FREQUENCY OF OCCURRENCE
Accounts payable entries don’t typically happen on a set schedule. They include expenses that come up as needed, like replacing a broken printer or paying a consultant for a one-time workshop.
Accrued expenses are often incurred monthly, like employee salaries and wages, rent and lease payments, and utility bills.
2. TIMELINE FOR PAYMENT
For accounts payable, payment occurs in the near future and is usually due within 12 months.
For accrued expenses, payment is due at the end of the accounting period, which could be monthly, quarterly, or annually (fiscal year or calendar year), depending on how the company handles its expenses.
3. STATUS OF INVOICE
Expenses recorded in accounts payable have an invoice or bill on record.
For accrued expenses, the company is aware of the expense and can plan for it, but they may not have received an invoice for it.
4. WHO RECEIVES PAYMENT
Accounts payable payments go to anyone who let your company purchase something on credit, like vendors, suppliers, or contractors.
Accrued expense payments typically go to employees, landlords or property owners, utility companies, etc.
5. PRECISION OF LEDGER ENTRIES
For accounts payable entries have a corresponding bill or invoice, so AP team members can record the exact amount due in the company’s ledger.
For accrued expenses, it’s possible that the exact amount due might not be known. (For example, a monthly energy bill—which fluctuates month to month—would be an accrued expense.) In that case, an estimate is recorded in order to best represent the company’s current liabilities until the exact amount is known.
Discover the Differences Between Accounts Payable and Accounts Receivable and Between AP and Notes Payable
How Can Automation Change the Future of Your Accounts Payable and Accrued Expenses Management?
It can be tricky for any company to know which expenses fall under accounts payable and which fall under accrued expenses. And though now you know the subtle differences between the two, there’s still the matter of actually processing those invoices—especially accounts payable invoices.
When it comes to handling physical and digital invoices, it takes time to enter that data accurately and quickly, to make sure third parties are paid on time and without errors.
That’s why many companies are pivoting to automation software to make managing both accounts payable processes and accrued expenses processes more efficient and manageable. MHC offers solutions for your AP department that will help your organization:
- Reduce processing time
- Lower per-transaction costs
- Eliminate data entry errors
- Avoid late payment fees
- Reduce physical papers to file
- Gain visibility into your process
- Take more control over payments
- Avoid payment fraud
Want to learn more? Discover what the MHC NorthStar platform can do for your company! Request a personalized demo today!