Cash to accrual for accounts payable and expenses?
If you are confused about how to go from cash to accrual for accounts payable and expenses, then you are in the right spot! Here is the video explanation that walks through all of the information that is laid out below!
This tutorial will describe the difference between cash and accrual accounting for accounts payable and expenses (invoice based expenses). You’ll learn how to use the balance sheet method, which can be used to answer almost any cash to accrual (or accrual to cash) question on accounts payable and expenses. We’ll also go through two examples so that you become a master of this method!
Fundamental Difference Between Cash and Accrual for Accounts Payable and Expenses
Under the cash basis method, we would record the expense for invoice based expenses when the company pays the invoice. However, under the accrual method, the company would recognize the expense when the invoice is received. Receipt of the invoice assumes that the supplier or vendor has completed their performance obligation.
So why is there typically a difference between the cash and accrual method?
The timing of when the invoice expense is recorded will likely vary based on the payment terms for the invoice. For example, if the company received the invoice on March 15, Year 1, then they should record the invoice and recognize the expense under the accrual method. However, if the payment terms were “due in 60 days”, then the company would likely withhold payment on the invoice until May 15th, Year 1. Therefore, the cash outflow for paying the invoice would occur on May 15th, which is when the expense would be recorded under the cash basis of accounting.
What Increases or Decreases Accounts Payable on the Balance Sheet?
It is critical that you understand what increases or decreases the accounts payable balance on the balance sheet. When a company receives an invoice, the invoice would be recorded in the company’s accounting records and accounts payable would increase. Accounts payable will decrease only when the company pays the supplier or vendor in cash for the outstanding invoice.
What Expense Types Result in an Invoice?
A company will likely receive an invoice for any product or service purchased from a 3rd party / unaffiliated company. The most common types of invoice expenses are the purchase of materials (capitalized into inventory), utilities, consulting services (legal, accounting, etc.), travel expenses (meals, entertainment, lodging, airfare), telephone expenses, and IT service providers (Salesforce, QuickBooks, etc.) The company would likely not receive an invoice for employee wages, rent (under a leasing arrangement), debt, etc.
Journal Entries Impacting Accounts Payable
Let’s go through the journal entries so that we understand what impacts accounts payable. Accounts payable will be increased when we receive an invoice. Now, we would likely receive an invoice for purchased materials, so the debit would be to capitalize those costs into inventory. The offsetting credit would be to accounts payable, which records the liability on the balance sheet. Similarly, if we receive an invoice for a period type cost (operating expense), then the debit would be to the most appropriate operating expense account with the offsetting credit to accounts payable.
When the company pays the invoice, we will always debit accounts payable to remove the liability and the offsetting credit will be to cash for the cash outflow).
Example #1 – Cash to Accrual Question
So let’s dive into an example cash to accrual question. If the question provides the amount of cash paid for invoices, then we know we’re going from cash to accrual. A question like this would likely ask for the amount of expense under the accrual method. Remember, under the accrual method, expenses are based on invoices received during the period and would not be based on what invoices the company paid off.
We’ll use the balance sheet approach and set up the accounts payable rollforward. We’ll start by plugging in the information the question gives us and then solve for the missing variable. Based on the rollforward, we would have received invoices for $500 during the period, which is the expense under an accrual basis. The rollforward MUST balance in order for this method to work properly. Always check your math!
Example #2 – Accrual to Cash Question
So this question is similar to the one above, except the question provides us with the amount of invoices received during the period. That means we need to solve for the amount of cash paid for invoices during the period, which would be expenses under the cash basis of accounting.
Similar to the prior question, plug the information in the question into the rollforward. In order for the rollforward to balance, the company would have paid $1,750 for invoices during the period. Again, remember to check your math!
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