Are Outstanding Checks Accounts Payable?

An outstanding check is a check that has been written to pay an expense or to purchase goods or services on credit by giving a check to the seller, and the check has not yet been honored by the bank. This brings to another typical accounting debate – whether or not outstanding checks should be regarded as accounts payable. In the following part, we will explain this in more detail below.

What are Outstanding Checks?

Outstanding checks are those checks that have been written by a company and included in its general ledger but are yet to be cleared or deposited by the bank. In other words, it has not been encashed by the recipient or cashed by the payee. The bank account is also important for the company or the business since the funds have moved out of their cash accounts but have not yet exited from the bank account.

The companies will review the bank reconciliations each month to note checks that may still be outstanding. These are checks that have been written and recorded in the accounting records and accepted by the recipient but have not as yet been cashed. Outstanding checks are another example of timing difference refers to the difference between the transaction and the time the check clears the banking system.

What are Accounts Payable?

Accounts payable are short-term obligations or amounts owed by a company to its suppliers, creditors, contractors, and other third parties. Common reasons a company accrues accounts payable include:

- Buying inventories, materials, or equipment for use in the business under an agreement that the buyer will pay at a later date
- Payment after having been served or having used a certain good or product is another method of payment.
- Outstanding payroll, taxes, interest, or any other obligations having required or which have to be paid.

Accounts payable are called so because they are liabilities that the company will need to ‘pay’ at some later date, generally within a year, often within the period of one month to three months. From the creditor’s point of view, accounts payable are accounts receivable of the organization that the creditors believe they will be able to recover. Accounts payable are also generally classified as current assets on the balance sheet of an organization.

When looking at the balance sheet, the analysts focus on the accounts payable line since it shows that the firm has to pay funds to its vendors and gives some impressions about the management of cash assets.

Whether Outstanding Checks is considered an account payable or not is an area of confusion for many people.

For accounting and record keeping, the outstanding checks are checks that have been written but not cashed, and these should not be recorded as the account payable. On the one hand, outstanding checks can be seen from the bank’s point of view as checks that have not been paid yet, while on the other hand, from the company’s point of view, those checks are already paid.

Here are several key reasons why outstanding checks do not qualify as accounts payable:

1. The Expense or Purchase has already been captured in The Books of Accounts

From the company’s standpoint, the outstanding checks are already accurately reflected in the accounting records and the respective financial statements. When the check was originally issued, it was recorded as either:

- An expenditure (about acquiring service or merchandise)

- A decrease in any of the other accounts in the balance sheet such as assets or reduction in liability.

Having recorded the issuance of the check in the books of the general ledger it does not make sense to consider this as a new liability. The books are realistic in the sense that they reflect that such a cost has been paid for already.

2. When the concept of writing a check is used in business, then it is important to understand that cash is reduced instantly.

Yet the bank account is not formally altered until the check is cashed while accounting records are instantly updated for the lower cash balance when the check is written. The company now holds less amount of cash in its Cash account and books this unsettled check under the ‘outstanding check’ account until it is cleared by the bank.

From the accounting perspective, it makes no sense to hit the cash twice which also means that there will be no addition of this amount to the accounts payable balance. Cash is already decreased due to it signifies that payment has practically left the company’s possession.

3. It should, therefore, be clarified that the Company no longer ‘owes’ the amount as the following paragraphs are going to illustrate.

Accounts payable are the amounts due to outside entities that remain genuinely payable for some specific product or service. However, when a company makes a payment and remits it, the books should not retain that this is an amount that is due to be paid.

The recipient is now legally obliged to the bank to pay this, hence a check drawn in their name formally puts this asset in the bank’s collection. However, the company’s legal responsibility has ceased to exist and thus eliminates the item from the accounts payable.

This raises the question of how outstanding checks are reflected on the financial statements of different organizations.

Instead of sitting in accounts payable, the amounts represented by outstanding checks are typically reflected in the following manner:

Balance Sheet

Cleared checks on the other hand are reported as a line item under Current Assets under the heading “Cleared Checks” or “Deposit in transit”. This sub-account captures all the checks that have been written and not yet recorded through the bank statement.

Outstanding checks at the prior month's end are debited to the Reductions to Cash account in the current month when they are cleared in the current bank statement. Outstanding checks that have been written for the current period are also included in the current total if they have been newly written during the current period and not previously written during the prior period.

Income Statement

The same would not pass through the income statement accounts as was the case when paying expenses or invoices of outstanding checks. The check would have been written and expense recorded at the time it was issued and that was the recognition of the income statement of costs related to that check.

Statement of Cash Flows

As for the changes in the outstanding checks and balances, they would be incorporated in the cash flow statement because they affected cash balances. This adjustment is made to correctly assess the cash that is genuinely generated or utilized by the business during the period.

Outstanding checks may be presented under a separately recognizable line item as (Increase)/Decrease in Outstanding Checks. Or, it may flow through as additions or subtractions to the presentation of specific cash flow categories such as the operating, investing, and financing categories based on the nature of the transaction.

Proper accounting treatment enables the accurate preparation of group financial statements to give a true and fair view of the group’s financial position.

Outstanding checks do indicate payments in transit, but if this item is considered and recorded as new accounts payable then it will only complicate and picture duplicated accounts in the balance sheets. However, a company effectively sustains the integrity of accounts when using outstanding checks as a placeholder in the Cash account until it receives clearance from the bank rather than using them as obligations that have not been paid.

Outstanding check classification between checks issued and accounts payable provides a real view of cash transactions and liabilities that are still owing at a period. Such a treatment aids in ensuring that the right presentation of the financial statements and balances due are determined.

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