Lesson 13: Accounts Receivable &

Accounts Payable

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Student Loans

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Income Statement

vs Balance Sheet

There are just three personal finance accounts for us to cover before I send you off with your Personal Finance Accounting degree. Two of them are popular accounts that many use regularly; Accounts Receivable and Accounts Payable. Accounts Receivable (also known as A/R) is an asset account on your Balance Sheet that represents short term IOUs owed to you. Since it is money that is owed to you, it is technically value that you own. Conversely, Accounts Payable (also known as A/P) is a liability account on your Balance Sheet that represents short term IOUs that you owe.

When you loan your friend a few dollars with the agreement he/she will pay you back soon, you are using your A/R account. When you purchase food for you and your friend with the agreement he/she will pay you back for his/her meal, you are using your A/R account. Or if we flip those and you are the recipient of the short term loan from a family member or friend, or when your friend buys food on your behalf with an IOU attached, you are using your A/P account. Let's go over some simple examples so you see exactly what I mean.

Example 13-1: You are at your friend's house and she decides to order food. You forgot your wallet so you tell her that you will pay her back for half of the bill if she covers the full bill now. The pizza, wings and salad comes out to $25. She pays for it and you now owe her $12.50. 

Part 1 - The purchase

Figure 13A

Left Side:

No asset accounts affected.

Right side:

  • Liabilities: Your half of the bill came out to $12.50 so that is now a debt you owe your friend. Instead of having individual accounts for each family member or friend, the Accounts Payable account is an umbrella account that keeps a running balance of your total short term debts owed (same with Accounts Receivable).

  • Equity: Here is the interesting part of this transaction​ - your friend paid for the food but half of it is technically your expense and not hers. Therefore, your half gets entered into your books as an expense to the appropriate account (Food & Dining: Fast Food) with a debit entry, thereby decreasing your Net Worth by $12.50.

Assets = Liabilities + Equity

$0 = $12.50 + ($12.50) 

$0 = $0

By using the A/P account in tandem with an expense account, your books/Balance Sheet accurately tracks the loss in Net Worth despite the fact that you did not actually spend any money yet. This is the beauty of accounting and bookkeeping! The science behind double entry accounting allows accounting systems to track complex, nuanced real world activities to the penny. 

Part 2 - The reimbursement:

Two days later, you send $12.50 to your friend via Cash App to settle your debts.

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13b.png

Figure 13B

Left Side:

Since you reimbursed her using your Cash App funds, the transaction decreases your Cash App Account with a credit entry.

Right side:

  • Liabilities: We begin this part with a $12.50 balance in the A/P account. The reimbursement adds a debit entry of $12.50 to the account, wiping out the short term debt you had (or "zeroing out the account").

  • Equity: No equity accounts affected since the Net Worth loss (expense) was already recorded with the purchase of the food. Again, highlighting the beauty of accounting and bookkeeping.

Assets = Liabilities + Equity

($12.50) = ($12.50) + $0

($12.50) = ($12.50)

Important N​ote: These examples are simplified snapshots into a much larger picture. For example, Figure 13B starts with a $12.50 balance in A/P. However, in real life there may be times where you have short term IOUs with multiple people. Let's say you also owe your mother $50 and you owe another friend $10. In that case, the beginning balance to A/P in Figure 13B would be $72.50 ($50 + $10 + $12.50) instead. If that were the case, the $12.50 reimbursement to one friend would not zero out A/P like it did in our example. It's important that you remember accounts are used in individual transactions but they are also running totals tracking the complete life of the account.

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For the next example, we will use the exact same scenario but we will flip perspectives. This time you are the one paying for the food on behalf of your friend.

 

Example 13-2: You decide to order food while a friend is over. She wants in on it but does not have her wallet. You tell her she can just pay you back in the next couple days. The pizza, wings and salad comes out to $25. You pay for it and your friend now owes you $12.50. 

Part 1 - The purchase

Figure 13C

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Left Side:

  • Cash Account: You used $25 cash to pay for the full bill. Therefore you Cash Account decreases (credited) by $25.​

  • Accounts Receivable: To account for the portion of the bill that your friend owes you, your A/R Account is increased (debited) by $12.50. This portion ensures you are not financially responsible for your friend's portion, even though you paid on her behalf.

Right side:​

  • Equity: The half of the bill for your food is recorded as a Fast Food Expense in your books. Despite having a cash outflow of $25, your Net Worth only takes a hit of $12.50 since only half the bill is yours and the other half will be reimbursed to you. Again, this is the beauty of accounting and bookkeeping!

Assets = Liabilities + Equity

($25) + $12.50 = $0 + ($12.50) 

($12.50) = ($12.50)

Part 2 - The Reimbursement:

Two days later, your friend sends you a Cash App for $12.50 to settle her debts.

Figure 13D

Left Side:

  • Accounts Receivable: You had a balance of $12.50 representing the IOU your friend owed you. The reimbursement reverses out that entry, resulting in a credit entry of $12.50. 

  • Cash App: Since your friend reimbursed you via Cash App, your Cash App balance is now $12.50 higher (debit entry).

Right side:​

  • No Liability or Equity accounts affected during this part of the transaction. The Net Worth loss was accounted for with the expense at purchase.

Assets = Liabilities + Equity

($12.50) + $12.50 = $0 + $0

$0 = $0

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There are a number of scenarios where we use the A/P and A/R accounts and numerous account combinations based on the scenario. Sometimes it's food, sometimes it's gas, sometimes it's beer, sometimes it's cash, sometimes it's your father, sometimes it's your sister, sometimes it's your friend, etc. No matter the specific variables, the Balance Sheet and double-entry mechanics will perform exactly like the examples above. 

You are now one lesson away from the complete picture. Continue to the next lesson to learn about the Income Statement and Retained Earnings Account.