Accounts Payable vs. Accrued Expenses: Invoices, Cash Flows, and Interview Questions

Accounts Payable vs. Accrued Expenses Definition: In accounting, Accounts Payable (AP) and Accrued Expenses (AE) record owed payments for products or services that a company has ordered and received but not yet paid for in cash; on the financial statements, they are often used for different scenarios, with AP corresponding to purchases with specific invoices and AE corresponding to recurring expenses that do not necessarily have invoices.

We frequently get questions about Accounts Payable vs. Accrued Expenses, as they represent similar concepts.

In many cases, the mechanics on the financial statements are quite similar, but they are used for different items, and Accounts Payable (AP) may have added nuances around the recognition and delivery of items:

To illustrate with a simple scenario, if a company orders a $100 service from an outside contractor but does not pay upfront, it records the expense on its Income Statement and then increases AP or AE on the Balance Sheet:

Initially, its Cash increases to reflect the tax savings combined with the lack of any cash payment for this expense, and the Liability line item and Common Shareholders’ Equity also change.

When the cash payment is made, Cash and AP or AE both decrease by $100:

Accounts Payable is used more often for irregular items with specific invoices outside of weekly/monthly schedules.

For example, if a company hires a marketing firm to run a one-time promotional campaign, the owed payment for that firm’s invoice will probably be in Accounts Payable.

By contrast, something like owed rent will be in Accrued Expenses since it accrues each month and is paid on a regular schedule.

Also, Accounts Payable is often used to record the purchases of items that eventually get delivered to customers and are not used internally by the company.

The classic example is Inventory: When a company purchases Inventory “on credit” and receives it with an invoice, it almost always uses AP to record the outstanding payment.

Nothing initially appears on the Income Statement because the company must convert this Inventory into finished products and sell and deliver them to customers.

Once it does that, it can then record the expense within Cost of Goods Sold (COGS).

Files & Resources:

• Accounting “Interview Question” Model – Accounts Payable Example for Inventory Paid On Credit (XL)
• Accounts Payable vs. Accrued Expenses – Presentation Slides (PDF)

Video Table of Contents:

• 0:00: Introduction
• 0:55: The Short Version
• 3:45: Part 1: Simple Accrued Expense Example
• 7:05: Part 2: Simple Accounts Payable Example
• 11:21: Part 3: AP and AE in Financial Models and Valuations
• 13:02: Recap and Summary

Simple Accrued Expenses Example

Expanding on the example above, if a company orders a service from an outside contractor for $100, receives the service, but has not yet paid for it in cash, it could potentially record this owed payment within either AP or AE.

We’ll assume AE in this example to differentiate it from AP in the next one.

It records this $100 expense on the Income Statement, which reduces its Pre-Tax Income and Net Income.

At a 25% tax rate, Net Income is down by $75.

It also increases the Accrued Expenses by $100 on the Liabilities & Equity side of the Balance Sheet to reflect this future owed payment.

On the Cash Flow Statement, Net Income is down by $75, but the Change in AE is +$100, reflecting the lack of any immediate cash payment for this owed expense:

Cash at the bottom of the CFS increases by $25 because of the tax savings the company gets from recording this expense and counting it as a tax deduction, but not yet paying for it in cash.

When the company finally makes the payment, the AE line decreases by $100, and so does Cash on the Assets side.

Both sides of the Balance Sheet are down by $100, and the BS remains in balance:

Nothing happens on the Income Statement when the payment is made in this step; the expense was recorded previously, and it’s still there if the IS shows the same period.

At the end of Step 2, Cash is down by $75 rather than $100 because there’s +$25 of tax savings combined with –$100 from the cash outflow.

This walkthrough assumes that both changes happen sequentially and walks through the net result at the end, over both steps. The numbers differ if you consider Step 2 in isolation.

Simple Accounts Payable Example

To illustrate how Accounts Payable differs, let’s say that a company orders $100 of Widgets that it needs to produce, sell, and deliver $180 of Products.

It does not pay for this $100 upfront; instead, it promises to pay the supplier as soon as it sells the Products and collects the cash.

This is called ordering “on credit,” and virtually all companies use Accounts Payable for this scenario.

After the company places the order, it gets the $100 in Inventory from the supplier and an invoice for the purchase.

Delivery to the company has taken place, but not to the end users – the customers that are paying $180 for these Products.

Therefore, the company does not record this expense on its Income Statement yet.

Instead, it increases its Inventory by $100 and its Accounts Payable by $100:

The Balance Sheet remains in balance because the Assets side is up by $100, and the L&E side is also up by $100.

In Step 2, the company turns these $100 of Widgets into Products and sells and delivers them to the customers:

-On the Income Statement, Revenue is up by $180, and it records the $100 Inventory cost within Cost of Goods Sold (COGS).

-Therefore, Pre-Tax Income is up by $80, and Net Income is up by $60 at a 25% tax rate:

-On the Cash Flow Statement, Net Income is up by $60, but Inventory now falls by $100, and Accounts Payable falls by $100.

When an Asset falls, cash flow goes up, and when a Liability falls, cash flow goes down.

So, these changes offset each other, and Cash at the bottom is up by $60:

-On the Balance Sheet, Cash is up by $60 on the Assets side, and Inventory is down by $100, so Total Assets are down by $40 in just Step 2.

-On the L&E side, Accounts Payable is down by $100, and Common Shareholders’ Equity is up by $60 due to the increased Net Income, so this side is also down by $40 in just this step.

The Balance Sheet balances.

From start to finish across both steps, the company’s Inventory and AP balances remain unchanged because they initially increased and then decreased.

The net difference is that Cash and Equity are both up by $60:

The intuition is that this company purchases Inventory, sells it for a profit of $80, and pays $20 of taxes on it, so its Cash balance is $60 higher.

Equity is also up by $60 because Net Income, or after-tax profits, increased by $60.

A company is unlikely to use Accrued Expenses (AE) to record this scenario because AE is rarely used for one-off orders with specific invoices.

Additionally, the nuance around the delivery to end customers vs. the company’s internal usage makes AP the more likely line item here.

Accounts Payable vs. Accrued Expenses in Financial Models

There is another difference as well: In 3-statement models, you tend to forecast Accounts Payable based on COGS, while you often link Accrued Expenses to Operating Expenses or the Selling, General & Administrative (SG&A) Expense.

You can see this in the 3-statement model example for Monster Beverage below:

Many companies use AP primarily for their Inventory and product/service delivery costs, so it makes sense to link it to COGS or Cost of Services.

By contrast, since AE is used for recurring, relatively fixed expenses such as rent, utilities, insurance, and employee salaries, it trends more closely with Operating Expenses.

You can think of it like this:

• Variable Expenses: COGS and Accounts Payable
• Fixed Expenses: Operating Expenses and Accrued Expenses

This division is not 100% accurate in all cases, but it’s a decent guideline.

The cash-flow impact is the same: Since AP and AE are both Liabilities, increases in these line items boost the company’s cash flow, while decreases reduce it (see our tutorial on the Change in Working Capital):

From a valuation perspective, a company that can delay payments to suppliers and vendors has a Free Cash Flow advantage that should increase its value in a Discounted Cash Flow (DCF) analysis, all else being equal.