![]() On the other side, AP or AE is now back to its old level and is no longer up by $100. Now, Step 2: What Happens When You Pay the AP or AE in Cash, For Realġ) No changes on the Income Statement – already recognized this as an expense!Ģ) Cash Flow Statement: Net Income is still down by $60… and now we REMOVE that adjusting entry for AP or AE, so cash no longer goes up by $100 from that.Īs a result, cash at the bottom is just down by $60.ģ) Balance Sheet: Cash is now down by $60 rather than being up by $40, because we just paid that expense in cash. INTUITION: You’ve saved on taxes because you recorded an expense, took the tax deduction, and reduced your tax bill… but you haven’t paid that expense in cash yet! It’s all about the tax savings in this first step. Our cash flow and ending cash at the bottom are up by $40.ģ) Balance Sheet – Cash is up by $40 on the Assets side on the L&E side, AP or AE is up by $100, but Retained Earnings is down by $60 due to the reduced Net Income, so both sides are up by $40. Let’s use the example of AP or AE of $100 on the 3 statements:ġ) Income Statement – Expenses (most likely OpEx) will increase by $100, reducing Pre-Tax Income by $100 and Net Income by $60 assuming a 40% tax rate.Ģ) Cash Flow Statement – Net Income is down by $60, but this expense we just recognized was non-cash, so we record the increase in AP or AE as a cash increase of $100. IF they both correspond to COGS or Operating Expenses IN THE CURRENT PERIOD and therefore refer to actual expenses listed on the Income Statement: What Happens on the 3 Statements When AP or AE Change? In between, that expense accrues because we use the building or office every day of the month… so it’s not accurate just to view it as an expense on one day of the month, but rather an expense that gets accrued every single day and then paid in cash at the beginning of the month.Įxample 1 corresponds to Accounts Payable, because we typically use AP for items with specific invoices.Įxample 2 corresponds to Accrued Expenses, which we typically use for recurring, monthly/quarterly/weekly items WITHOUT specific invoices, such as rent, utilities, employees’ wages, and so on. They already performed the service, so we incurred the expense, but we haven’t paid them in cash yet.Įxample 2: We pay rent at the beginning of each month. However, AP is more likely to correspond to events such as the purchase of Inventory, which would NOT show up on the Income Statement initially, and so you’re more likely to see different treatment with Accounts Payable (no Income Statement impact – just an Asset on the Balance Sheet increasing and AP on the Liabilities & Equity side increasing to balance the change).īoth these items represent cases where we’ve INCURRED an expense but not actually paid for it in cash yet.Įxample 1: We get an invoice for a legal bill from a law firm we hired. THE SHORT ANSWER: Accounts Payable (AP) and Accrued Expenses (AE) work in a VERY similar way… IF they both correspond to Operating Expense line items, or other items that appear directly on the Income Statement. It’s a common interview question! You may be asked about the differences between them, how changes are reflected on the 3 financial statements, and so on.Īnd most Google search results on this topic are AWFUL and do not answer the actual question at all, or do so in a confusing way that misses the point (trust me, I looked). ![]()
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