Examining Your Business's Liability Accounts - dummies

Examining Your Business’s Liability Accounts

The activities of a business involve inflows and outflows of cash, as you know. What you might not know, however, is that accountants use three different types of liability accounts to record a business’s unpaid expenses.

Accounts payable

You use your accounts payable liability account for items that your business buys on credit. You record the amount that you owe as soon as you receive an invoice — for example, an invoice from your business’s lawyers for work they did drafting employment contracts. Later, when you pay the invoice, you subtract that amount from the accounts payable account, and your cash goes down by the same amount.

Accrued expenses payable

Your business may need an accrued expenses payable account to estimate several unpaid costs at the end of the year because you haven’t yet received invoices for costs. Examples of accrued expenses include the following:

  • Unused vacation and sick days that employees carry over to the following year, which the business has to pay for in the coming year

  • Unpaid bonuses to salespeople

  • The cost of future repairs and part replacements on products that customers have bought and haven’t yet returned for repair

  • The daily accumulation of interest on borrowed money that you won’t pay until the end of the loan period

Because you don’t have invoices to refer to, you have to examine your business operations carefully to determine which liabilities of this sort you need to record in your accrued expenses payable account.

Income tax payable

Businesses use this account for income taxes that a business still owes to the IRS at the end of the year. The income tax expense for the year is the total amount based on the taxable income for the entire year. Your business might not have paid all of its income tax expense during the year; it might owe a small fraction to the IRS at year’s end. You record the unpaid amount in the income tax payable account.

A business may be organized as a pass-through tax entity for income tax purposes, which means that it doesn’t pay income tax itself but instead passes its taxable income on to its owners. The example offered here is for a business that is an ordinary corporation that pays income tax.