Accounts Payable vs. Accrued Expenses - Interview Question

Accounts Payable vs. Accrued Expenses on the 3 Financial Statements: Why Does It Matter?
By http://breakingintowallstreet.com/ "Financial Modeling Training And Career Resources For Aspiring Investment Bankers"
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.

And 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).

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.

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).

Both these items represent cases where we've INCURRED an expense but not actually paid for it in cash yet.

Example 1: We get an invoice for a legal bill from a law firm we hired. They already performed the service, so we incurred the expense, but we haven't paid them in cash yet.

Example 2: We pay rent at the beginning of each month. 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.

Example 1 corresponds to Accounts Payable, because we typically use AP for items with specific invoices.

Example 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.

http://www.mergersandinquisitions.com/