Accounts Payable

What is Accounts Payable?

 Accounts payable is the amount owed for the purchase of goods or services at a specific
date.
 It is the money that a company owes to vendors for products and services purchased on
credit extended in the normal course of business.
 As a general practice suppliers offer to their customers credit, which is an payment
arrangement to pay for a product or service after it has already been received.
 Accounts Payable is presented as Current Liabilities under the Liability section of the
Balance Sheet. It represents a negative cash flow for the company.
 Accounts payable are often referred to as "payables".
 Accounts Payable is considered as Current Liability, meaning that it is a short term credit
extended to the business expected to be fulfilled in less than a year

How do we define Accounts Payables:

We all use utilities. For example we take various services from the phone company, the gas
company and the cable company. They provide us the goods and services first and as the end
of the agreed billing period they raise an invoice on the customer. In this case the Utility
Company is our Creditor and they have provided us the service on credit. The amount payable
to the utility company is the “Account Payable” for us, which needs to be paid in very short-term
to the utility company (Supplier/Creditor) to enjoy continued services.

Similarly credit is extended in the normal course of business to the customers on purchase of
goods and services and needs to be paid off within a given period of time in order to avoid
default.

Payables are often categorized as “Trade Payables” & “Expense Payables”. “Trade Payables”
are the monies due for the purchase of physical goods that are recorded in Inventory. “Expense
Payables” are the monies due for the purchase of goods or services that are expensed.
Common examples of Expense Payables are utilities like telephone and electricity.

Accounts Payable Department

Large companies have huge number of suppliers. To remain competitive they need to manage their
procure to pay process very effectively. They create specialized division to handle these operations.
The business department that is responsible for making payments owed by the company to
suppliers and other creditors is also often referred to as Account Payable (AP).

Accounts Payable Journal Entry

Although in the large organizations the Procure to Pay Accounting process starts when the purchase
order for supply of goods is released to the supplier. To keep things simple in the beginning we will
discuss the core accounting entries related to the Accounts Payables process.

Receipt of Goods:
You issue purchase order to the supplier and he supplies you with the goods. Once the ownership of
the goods gets transferred from the supplier to us, we account for the goods as our inventory and
based on the invoice received from the supplier need to create a liability for the payment due to him.
At this stage the accounting entry is:

Debit    Inventory Account

Making Payment to the Supplier:

Debit     Accounts Payable Account

Given below is the complete Accounts Payable Process:

1. Issue Purchase Order:

The AP Process starts with the issue of Purchase order to the Supplier. The purchase order
specifies what you intend to buy, the make and the quality of the goods. In some cases it also
specifies the agreed quantity and the price.

2. Receive Goods:

Based on the purchase order the supplier will ship a product. Till goods have been received by
the customer, the ownership generally lies with the supplier. Once the goods are received at
your go down, you become the owner of the goods.

3. Inspect Goods:

Most organizations have the internal control processes to inspect the goods to ensure the
quantity and quality of the supplied material.
4. Enter Invoice:

Supplier issues an credit invoice, and collects payment later. This describes a cash conversion
cycle, a period of time during which the supplier has already paid for raw materials but hasn't
been paid in return by the final customer. Received invoice is accounted for in the books of the
customer.

5. PO Match and Receipt Match:

When the invoice is received by the purchaser it is matched to the packing slip and purchase
order, and if all is in order, the invoice is paid. This is referred to as the three-way match. The
three-way match can slow down the payment process, so three-way matching may be limited
solely to large-value invoices, or the matching is automatically approved if the received quantity
is within a certain percentage of the amount authorized in the purchase order.

6. Release and Make Payment:

Once the matching is done and accounts payable department is satisfied to the accuracy and
validity of purchase, the refer to the payments terms. Companies may have negotiated different
payment terms with different suppliers. Payment is released based on the agreed payment
terms and amount is issued to the supplier.

7. Bank Reconciliation:

Generally the payment is made through the bank. There is a slight delay between the date when
the payment is released and when it reaches to the account of the supplier. The bank entry is
reconciled to the original payment entry in the Payments Register to reconcile the both accounts
and this completes the account payable process.