Payment in arrears definition
/What is Payment in Arrears?
A payment in arrears has occurred when a payment is made to a supplier later than the terms of the arrangement under which goods or services were to be purchased from the supplier. The amount in arrears is the amount of the account payable that should have been paid as of the earlier due date.
Example of a Payment in Arrears
For example, ABC International is paying off a long-term debt with monthly payments of $1,000. Through an error in the accounts payable department, the February payment was not made, though all successive payments of $1,000 were made. From the perspective of the lender, ABC continues to be $1,000 in arrears for the most recent amount due, since the lender is likely applying each $1,000 payment to the oldest amount due.
The Implications of a Payment in Arrears
Any type of payment that is in arrears may be a sign of financial difficulty that a creditor or investor should be wary of, since it may indicate a deliberate intent not to pay. A continuing pattern of payments in arrears will likely trigger some sort of restrictive action, such as calling a loan early, an increase in the interest rate charged, reduced payment terms, a reduction in credit, or the revocation of credit. A situation where a single payment is in arrears but is then paid is more likely to indicate any of the following causes:
There was a dispute regarding the goods or services provided
The supplier did not issue an invoice
The supplier sent an invoice to the wrong location
The buyer lost or incorrectly recorded the invoice in its internal systems
The buyer changed to a new accounting system and did not record the payable in the new system
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What Types of Payments are Made in Arrears?
The payment in arrears concept can simply mean that a payment is scheduled to be paid at the end of a period, rather than at the beginning of a period. If such is the case, a payment in arrears is not a late payment. Here are several situations in which these types of payments are made:
Salaries. A salary is typically paid at the end of a payroll cycle for work already performed. This approach allows the employer to precisely determine the amount owed to each employee, which would not have been the case if the payment had instead been made in advance. In addition, a payment in arrears gives the employer time to review all payroll calculations, deductions, and payroll taxes, to ensure that they were correctly made.
Utility bills. A utility typically waits until the end of the month to measure how much of the applicable resource you have consumed (such as electricity or gas), and then bills you in arrears for this amount.
Loan payments. Loan payments are usually made at the end of the month, and include the interest accrued during that period.
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