Accounts Payable(Quick Test #2 with Coaching)

Accounts payable are also known as trade payables. If a company uses short-term notes payable and accounts payable in its purchase transactions, the term trade payables covers both the accounts payable and these short-term notes payable.

Accounts payable is reported on the company’s balance sheet as a current liability since the amounts are typically due within a month or two. (Current liabilities are obligations due within one year of the balance sheet date, or within the operating cycle when the operating cycle is longer than one year.)

Working capital is defined as current assets minus current liabilities. Since accounts payable is a current liability, it is an important part of the working capital calculation. Accounts payable also affects the current ratio, which is current assets divided by current liabilities.

Prior to authorizing payment of a vendor's invoice, the three-way match compares and confirms that the details in the following three documents are in agreement:

• Company's purchase order
• Vendor's invoice
• Company’s receiving ticket/record

Some companies use an internal form known as the accounts payable voucher to which the above documents are attached.

Since the vendor’s terms were FOB Shipping Point, the ownership of the goods was transferred to AVCO on December 30 (the date when the goods were put on a commercial truck at the vendor’s dock).

Since the goods in transit are now owned by AVCO, the cost of $5,000 must be reported on AVCO’s December 31 balance sheet as the current asset inventory and the current liability accounts payable.

The following diagram illustrates the situation:

The accrual method of accounting requires that expenses be reported on the income statement and the related liability on the balance sheet when they occur. [The date that a bill or vendor’s invoice is paid or the date when the bill or vendor’s invoice is received does not determine when an expense or liability occurred.]

In this question, the repair work occurred or was completed on December 31. Therefore, as of December 31, AVCO had the repair expense and the related liability. [Not having the vendor’s invoice in hand does not allow AVCO to omit the repair expense and liability from its December 31 financial statements.]

If the vendor's invoice was not processed prior to issuing its December 31 financial statements, AVCO must record an accrual-type adjusting entry that debits Repairs Expense and credits Accounts Payable (or Accrued Expenses Payable) for the estimated cost of $8,000. Failure to record the adjusting entry means that AVCO’s:

• Expenses will be too low
• Net income will be too high
• Current liabilities will be too low
• Owner's or stockholders' equity will be too high

Note: There was no change in AVCO’s cash as of December 31.

The credit terms 1/10, net 30 indicate that the buyer may deduct 1% of the amount owed if the invoice is paid within 10 days. (The amount owed is the original invoice amount minus any returns and allowances.) If the invoice is not paid within 10 days, the buyer must pay the full amount owed (the 1% discount is not allowed).

If the buyer uses the periodic inventory method and pays within 10 days, the buyer will record the 1% discount as a credit to a contra-purchases account such as Purchases Discounts, Cash Discounts, or Early Payment Discounts. If the buyer uses the perpetual inventory method, the buyer will credit the Inventory account for the $10 discount.

While ELCO's purchase was $10,000 based on the supplier's list prices, ELCO's cost was $7,000 ($10,000 minus the 30% trade discount of $3,000). Therefore, ELCO will record the purchase at its cost of $7,000.

Since this supplier's invoice also has credit terms of 1/10, ELCO may deduct an additional 1% from the cost if the invoice is paid within 10 days.

Therefore, if ELCO pays within the discount period of 10 days, it can deduct $70 (1% of the $7,000) and remit $6,930.

The calculation is shown here:

Under the gross method of recording accounts payable, JAYCO will enter the invoice amount of $1,000 as a debit to the Purchases account, and $1,000 as a credit to Accounts Payable on February 5.

When paying the vendor on February 13, JAYCO will debit Accounts Payable for $1,000 and will credit Cash for $990 and will credit Purchase Discounts for $10 ($1,000 X 1%).

In accounting, cost is defined as the cash or cash equivalent amount spent for an item. When the net method of recording accounts payable is used, the cash or cash equivalent amount is recorded in the accounts.

In question 8, there is an early payment discount of 1%. Therefore, JAYCO will record the cash price of $990 ($1,000 minus 1% of $1,000) on February 5 with a debit to Purchases and a credit to Accounts Payable.

When JAYCO pays the vendor on February 13, JAYCO will debit Accounts Payable for $990 and will credit Cash for $990).

With the net method of recording accounts payable, JAYCO would have debited Purchases for $990 and credited Accounts Payable for $990 on February 5. The $990 was the invoice amount of $1,000 minus the $10 discount allowed by the vendor if JAYCO pays in 10 days instead of 30 days.

Since JAYCO is paying the vendor on March 5, JAYCO is not entitled to the early payment discount of $10. Therefore, JAYCO must remit $1,000 on March 5.

This means that JAYCO’s accounting entry on March 5 will include:

• A credit to Cash for $1,000 for the amount owed.
• A debit to Accounts Payable for $990 (since this account was credited for $990 on February 5).
• A debit to Purchases Discounts Lost for $10 (for the entry to have debits equal to credits).

Purchases Discounts Lost is an income statement account similar to Interest Expense, since it implies that JAYCO did not have the money to pay the vendor the cash price by February 15.

Any amount in the Purchases Discount Lost account indicates to JAYCO’s management that its accounts payable department failed to take advantage of the attractive early payment discount.

The credit term 2/10, net 30 allows the buyer to deduct 2% from the amount due (original invoice amount minus any returns and allowances) provided that the buyer pays within 10 days of the date of the invoice (or within 10 days of the date the invoice was received).

In Question 10, XLCO received goods and an invoice for $6,000. However, XLCO also received a credit memo for $200 for the damaged goods. Therefore, the amount owed to the vendor is $5,800.

Since XLCO is paying within the 10-day discount period, it is allowed an early payment discount of $116 (2% of $5,800). This means that XLCO should remit $5,684 ($5,800 minus $116).

The calculation is as follows:

If ESCO pays the vendor’s $10,000 invoice having terms of 2/10, net 30 within 10 days instead of in 30 days, ESCO will save paying $200 ($10,000 X 2%). In other words, ESCO will save $200 for paying 20 days earlier than the due date.

To annualize the percentage earned/saved, we will convert both the $200 and the 20 days to annual amounts. This is done by multiplying both the $200 and the 20 days by 18:

• Amount saved on an annual basis: $200 X 18 = $3,600
• Converting 20 days to a year: 20 days X 18 = 360 days

Saving $3,600 per year on an investment of $9,800 or $10,000 = approximately 36% on an annual basis.

The annual percentage assumes there will always be invoices offering the 2/10 early payment discounts throughout the year.

If a company must borrow money for 20 days at the loan interest rate at 12% per year in order to pay the $10,000 invoice in the discount period, the net savings will be $135.56:

• Loan interest expense from borrowing: $64.44 ($9,800 X 12% per year X 20 days/365 days)
• Early payment discount: $200.00 ($10,000 X 2%)
• Savings after subtracting the loan interest $135.56 ($200.00 minus $64.44)

Note that the $200 early payment discount is approximately 3 times the 12% interest rate on the loan. This also indicates that the annual interest rate earned by paying within the discount period is approximately 36%.

It is common for companies to experience vendor invoices for large amounts involving a company’s equipment. The large amount could be either of the following:

• Capital expenditure. This is an addition or an improvement to the company’s Equipment, which is a long-term asset often referred to as a fixed asset or plant asset. This additional cost will then be depreciated over the remaining useful life of the equipment.
• Repair or maintenance expense. Some vendor invoices can be for large amounts, but they are for neither an addition to the equipment nor a significant improvement to the equipment. In other words, the huge cost may only restore the equipment to its working condition before the breakdown. As a result, this huge cost must be debited to Repairs & Maintenance Expense.

In Question 12, we see that the vendor’s invoice for $45,000 was a repair to get the equipment back to its previous operating condition. Therefore, the account to be debited for $45,000 is Repairs & Maintenance Expense.

To avoid a duplicate payment to a vendor, some companies have the following policy:

• Pay only from the vendor’s invoice.
• Never pay from a vendor’s statement.

This policy does not guarantee that a duplicate payment will not be made, but it will reduce the chances. Therefore, companies should have additional policies and controls for processing accounts payable.

Accountants define the cost of an asset as: all costs necessary to get the asset in place and ready for use.

In Question 14, we find that all five of the invoices were necessary to get the new production equipment in place and ready for use. (If the installers broke something, the cost associated with that problem is expensed, since that cost was not a necessary cost to get the asset in place and ready for use.)

Therefore, the answer to Question 14 is that Invoices 1, 2, 3, 4, and 5 should be debited to the long-term asset Equipment. That total cost minus any expected salvage value is then depreciated over the remaining useful life of the equipment.

Form 1099-NEC, which is entitled Nonemployee Compensation must be given to a non-corporation independent contractor that provided services and was paid $600 or more during the calendar year. Form 1099-NEC is pertinent to accounts payable because independent contractors submit invoices to companies. (The IRS provides guidance for distinguishing between an independent contractor and an employee.)

Form W-9 is entitled Request for Taxpayer Identification Number and Certification. This form is pertinent to accounts payable since the independent contractor’s taxpayer identification number must be included on Form 1099-NEC.

Form W-2 is entitled Wage and Tax Statement and is given to JJCO’s employees within a month after each calendar year. Each Form W-2 reports the gross wages paid to the employee as well as withholdings for income taxes, Social Security wages and tax, Medicare wages and tax, and other information pertaining to the calendar year. This form is part of the company’s payroll processing.

Form 1040 is entitled U.S. Individual Income Tax Return which is filed by individual taxpayers to report taxable income and other information to the IRS.