Understanding What Accounts Payable Is

Accounts Payable is money owed by the business owner to their suppliers for products or services that they have purchased on credit. One Businesses Accounts Payable is another Businesses Accounts Receivable. In order for you to effectively control your money flow you need to have a good Accounts Payable System.

The basic process of accounts payable is as follows:

  1. The Business Owner Purchases Goods or Services on Credit
  2. They receive an invoice for the Purchase
  3. The Trading Terms of the Supplier determines how long you have to pay
  4. The Supplier issues Statements at the end of each month
  5. If Payment hasn’t been made within Trading Terms Debt Collection may be undertaken
  6. The Business Owner Pays for the Goods or Services
  7. The Payment comes out of their bank account

Larger Companies have an Accounts Payable Department who take the above steps a bit further:

  • Purchase Orders are issued for the majority of purchases
  • Delivery Dockets are checked and authorised when the product is delivered
  • Contracts and other agreements are monitored
  • The amount of money paid out for goods or services is monitored
  • The amount of money owed to suppliers at the end of each month is monitored

The Accounts Payable Department is in charge of making payments on behalf of the company and applying it against their current balances in a timely manner. They are responsible for accurately recording the purchases to the correct ledger accounts.

Small Businesses generally do not have Accounts Payable Departments, but the person responsible for the overall accounting/bookkeeping still undertakes the same roles.

Businesses who sell Goods or Services on Credit are known as Creditors.

The efficiency and effectiveness of the accounts payable process will also affect the company’s cash position, credit rating and relationships with its suppliers.

Related Expense or Asset

Accounts Payable is based on purchases made by the business, it doesn’t matter what type of purchase it is, it still goes through as Accounts Payable. When making purchases, the business could be purchase any of the following:

  1. A product or service from a supplier that goes towards the cost of sales by the business. For example, milk to make the coffees at a Café. This purchase will be allocated to the Cost of Sales Expense account
  1. A product or service from a supplier that is for the everyday running of the business. For example the repairs and maintenance for in and around the Café. This purchase will be allocated to the Expense Account – Repairs and Maintenance.
  1. A business may purchase a piece of expensive equipment for the Café, like a fridge for the drinks or a coffee machine. Because these purchases are over $1,000 they are actually the purchase of an Asset, so the account affected by this purchase would be Plant and Equipment.
  1. Another purchase could be for a service that the supplier will provide in the future, but payment is due in advance. For example, Insurance on the Café building, the premiums paid for insurance are usually paid in advance.

It is really important that the accounts payable process is efficient and accurate so that there are no omissions or accidental double recording of entries. If a purchase is omitted from entry then the liability (Trade Creditors) wont increase and the Purchase Expense wont increase either, therefore the Balance Sheet and Income Statement will not reflect the purchase at all. If a purchase is entered twice then the Liability and expense accounts will be overstated.

Terminology

Purchase Order

A Purchase Order is prepared by the business that is making the purchase to communicate and document exactly what the business is ordering from their supplier.   The Purchase Order indicates the following:

  • A Purchase Order number
  • Date it is prepared
  • The Business name
  • The Suppliers Name
  • Name and phone number of the person organising the purchase
  • A description of the products being purchased
  • The quantity being purchased
  • Unit prices
  • Shipping method
  • Date required
  • Any other information that may be required.

Several people will need to receive the purchase order, the will include:

  • The person requesting that a Purchase Order be issued
  • The Accounts Payable Department
  • The receiving department
  • The Supplier
  • The person preparing the Purchase Order

Delivery Dockets

The Supplier issues delivery Dockets when goods are delivered. They are used to check what was delivered against the purchase order.

Once the Delivery Dockets are reconciled with the Purchase Order they are then compared to the Suppliers Invoice to make sure all three match.

Supplier Invoices

Invoices (bills) are issued by the supplier once the product has been delivered on credit. When the invoice is received the Accounts Payable Department will compare it to the Delivery Docket and the Purchase Order. Once it is reconciled it will be entered into the system against an expense or asset depending on what was purchased.

Supplier Statements

Most Suppliers will send statements to their customers to indicate the amount that remains unpaid. When a Supplier Statement is received the details on the statement should be compared to the businesses records. If there are any discrepancies then they need to be followed up as soon as possible.

Payment Terms

As the Purchase is on account the Supplier will offer Trading Terms or Payment Terms. The business is free to pay the amount owing before the due date and some Suppliers offer discounts to encourage this to happen.

Understanding Descriptions of Trading Terms is important so that you can make sure what you purchase is paid on time or you can pick up a discount if it is available. Following is a description on the most common Trading Terms used:

Credit Term Brief Description
Net 10 Days The net amount is due within 10 days of the date of the invoice
Net 30 Days The net amount is due within 30 days of the date of the invoice
Net 60 days The net amount is due within 60 days of the date of the invoice
Net EOM 14 The net amount is due within 14 days after the end of the month (EOM)
Net EOM 30 The net amount is due within 30 days after the end of the month (EOM)
Net EOM 60 The net amount is due within 60 days after the end of the month (EOM)
2/10, n/30 If paid within 10 days of the invoice date, the buyer may deduct 2% from the net amount; If paid in 30 days of the invoice date, the net amount is due.
1/10, n/60 If paid within 10 days of the invoice date, the buyer may deduct 1% from the net amount; If paid in 60 days of the invoice date, the net amount is due.

Ageing of the Accounts Payable

On your Balance Sheet the Accounts Payable is only a total figure owing at the time, it does not detail what makes up that figure. To obtain a detailed report of what makes up this figure, most Accounting Programs have a report called Accounts Payable Aging Summary Report. This report is useful in determining Cash Flow, as you can work out what needs to be paid when.

The Ageing Summary Report details each Supplier and the amount that is owed to them. It is divided in categories for current, 30 days, 60 days, 90 days or longer. The report is generated by sorting unpaid purchase invoices (bills) by Supplier and then by the date of the purchase invoices. The report indicates how much of its account payable is past due and how far past due they are.

Aged Payables
Local Accounting Firm
June 2015
Current May April March Older Total
Payables
Local Paper $920.00 $0.00 $0.00 $0.00 $0.00 $920.00
Local Stationery Shop $48.50 $67.75 $0.00 $0.00 $0.00 $116.25
Local bookkeeper $0.00 $328.90 $0.00 $0.00 $0.00 $328.90
Stock Supplier $8,140.80 $3,790.00 $0.00 $0.00 $0.00 $11,930.80
Landlord $1,920.00 $1,920.00 $0.00 $0.00 $0.00 $3,840.00
Local Car Dealership $0.00 $0.00 $0.00 $0.00 $18,840.00 $18,840.00
Stock Supplier 2 $3,057.00 $0.00 $0.00 $0.00 $0.00 $3,057.00
Telephone Company $441.13 $0.00 $0.00 $0.00 $0.00 $441.13
Local Milk Bar $0.00 $3.10 $0.00 $0.00 $0.00 $3.10
Total Payables $14,527.43 $6,109.75 $0.00 $0.00 $18,840.00 $39,477.18

Credit Notes (Adjustment Notes)

On occasion the business will need to return a product that they have received or they will need to get their money back on a service that wasn’t provided correctly. This is done by the returning the goods and requesting an Adjustment Note or receiving an Adjustment Note on the service.

The adjustment note is entered in to the Accounting Program and is allocated against the original invoice that related to the original purchase, or a refund of monies is given.

Now that you understand what Accounts Payable is, set your business up so that you can watch your cash flow and make your money work better for you J If you need to understand what Accounts Receivable is then you can read my blot – Setting up an Accounts Receivable System.




Please note: I reserve the right to delete comments that are offensive or off-topic.

Leave a Reply

Your email address will not be published. Required fields are marked *