Accounting Rules for Payable & Receivable

Accounting Rules for Payable & Receivable
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In their financial statements, many businesses report a substantial portion of their assets as coming from receivable accounts. Beginning investors are sometimes surprised to learn that although a business might be reporting these assets, they haven't actually been realized in cash yet. Payables -- money owed by the business to vendors -- are usually more straightforward. In either case, learning some of the rules that govern accounting for payables and receivables can help ease confusion.

Accrual Basis for Receivables

In most cases, companies that use receivables and payables account for their business activities using the accrual basis of accounting. The fundamental rule underlying the accrual basis is that revenues from receivables are recognized when they are earned, even if they are not yet paid.

Receivables are not recognized on the cash basis of accounting; companies on the cash basis record transactions only when cash actually changes hands. Because of this concept, revenues can be much larger than the company's bank account would suggest, especially if the company relies heavily on receivables for income.

Accrual Basis for Payables

Similar to the rule with receivables, reporting on the accrual basis for payables means that the company records debts as expenses even if it has not yet paid them. The company does not record all of its hypothetical expenses, only those that it is specifically obligated to.

On the cash basis of accounting, companies do not record payables because they do not represent cash expenditures. Recording debts when they are obligated usually provides a more accurate picture of the company's performance -- businesses can fail if they have too much debt, even if they appear to have substantial cash.

Current vs. Long-Term Assets or Liabilities

Both receivables and payables can be reported as either current or long-term assets and liabilities. Generally, the rule for recording a receivable or a payable as a current asset or liability is whether it is expected to be realized as cash within a year.

For example, if the company purchases materials from a vendor on credit, it would be considered a current liability only if the terms required payment in less than one year from the purchase. If the vendor extends credit for longer, only the portion of the payment due within a year is considered current.

Cash Transactions

Accounting rules require businesses to record a transaction whenever it pays its bills to creditors or receives cash from customers. It is important to keep in mind, though, that these transactions are not recorded as either new revenue or expenses. This is because they were recognized when they were agreed to, so the commitment of cash does not change the business's equity. Only the changes to the cash account are recorded when receivables or payables are realized.

Because the due dates for receivables and payables do not always line up, the company must keep a careful eye on its cash flow to make sure money is available to meet obligations when they come due.