written by khatabook | November 22, 2022

Understanding Accounts Payable | Definition, Process and Examples

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Table of Content


To run efficiently and ensure a positive image in the market, a business needs to pay its vendors, suppliers and various other partners their amount due on time. Accounts payable help showcase a specific amount in the general ledger of the organisation’s books of accounts, which describes its obligation of payment of all statutory dues and short-term debts to all the company's vendors, suppliers and creditors. There is a stated process of accounts payable and various examples to help understand the term to our readers, which we will discuss later in this blog. 

Did you know? The concept of accounts payable is directly opposite to the concept of accounts receivable. 

Accounts Payable Definition and Importance

As an accounting term, accounts payable refers to the amount the organisation owes its vendors, suppliers and creditors. They are shown on the liability side of the balance sheet. Explaining in simple words, when we buy various kinds of goods or avail different services with the possibility of payment at a later date, and such amount until it is paid to the relevant person or the business involved, is termed as accounts payable of the organisation.

The sum of all the outstanding amounts due for payment to the external stakeholders is recorded in the firm's balance sheet. In contrast, any kind of increase or decrease in the total amount payable will appear in the company's cash flow statement. 

Also Read: Know the Basics of Managerial Accounting

Importance of Management of Accounts Payable 

Account Payable is an essential figure in a company's balance sheet. If AP increases over a prior period, that means the company is buying more goods or services on credit rather than paying cash. 

  • Any kind of procurement of goods with the facility of paying on a later date results in a huge cash outflow on a later date to pay the amount due. Hence, the company must manage this efficiently.
  • Delayed payments may lead to a bad word of mouth by the company's external stakeholders in the market, leading to a deterioration of the business's credibility.
  • High carrying costs are involved under accounts payables, not only the additional charges for delay in payment but other costs also, which is why a business needs to manage their accounts payables efficiently.

Accounts Payable Process And Elements To Execute 

The end-to-end process of accounts payable of an organisation involves four distinguished steps, which are as follows:

  1.  Capturing invoice

It involves manually entering all kinds of invoice data like the details of the vendor, various line items and the sum of the amount due into a system which records this information and also shows all kinds of risks which are associated with accuracy or any kind of human error.

  1.  Approval Of Invoice

It involves reviewing the invoices and taking approval of all kinds for supplier invoices. Members of the account payable team often send the paper invoice around the office for approval purposes and it is done before posting it as a cost in the ERP system and sending the payment amount.

  1.  Authorisation Of Payment 

Once the invoice is completely ready for payment, the firm will need to get prior authorisation of proceeding to make the payment of the amount due, which involves the specific date on which the firm will submit the payment and the type of method that will be used for payment, and the relevant payment amount which is due.

  1.  Execution Of Payment 

After following all the necessary steps of the payment authorisation process, the invoice is finally paid and all the necessary remittance details are then sent to the specific vendor, which involves the printing, signing, mailing of checks or the completion of credit card payments. Since the payment is made, now the invoice will be deemed to be closed out of the system.

Also Read: 3 Golden Rules of Accounting Explained with Best Examples

Important Elements For Execution of the Accounts Payable Process

An increase in accounts payable will result in an inflow of cash and increase the cash and cash equivalents. In contrast, a decrease in accounts payable will result in cash outflow, leading to a decrease in cash and cash equivalents.

1. Purchase Order 

A purchase order is required to initiate the purchase and is sent from the purchasing department of the organisation to the relevant vendor. It involves a list of the merchandise requested for purchase, the quantities of each item requested and the final price of the order made by the organisation.

2. Receiving Report 

After receiving the merchandise from the purchasing department, a receiving report is prepared to document the shipment order, which would involve any kind of damages to the goods or any discrepancies related to the order made by the organisation. 

3. Vendor invoice 

After all the preceding steps are followed, a vendor invoice is prepared and sent by the vendor himself to the organisation that had requested the purchase of goods to request for the payment of goods and services availed. The accounts payable teams receive the vendor invoice and initiate the invoice management process.

Also Read: Learn About Accounting Principles and Concepts

Accounts Payable Examples And Role of Internal Control 

Let’s take the help of an example to understand the meaning of accounts payable:

Let’s suppose that Max enterprises have purchased goods amounting to 1,00,000 from Ace Traders and Ace traders offered a credit period to Max enterprises of 30 days, within which the amount due shall be paid by Max enterprises.

In the above-stated diagram, until and unless Max enterprises pay up the amount of 1,00,000  to Ace traders, the amount will be treated as accounts payable by Max enterprises. It will be shown as a liability towards creditors in the balance sheet in the books of Max enterprises.

Internal control and the audit of the accounts payable process are important for an organisation. Data showed that 82% of organisations were subject to fraud in 2021 due to poor internal control and lacklustre auditing. The availability of sufficient audit procedures is required to reduce improper payments, ensure regulatory compliance is complied with, and reduce any kind of risk of human error.

Also, internal control and audit are important aspects to ensure safety and security in the organisation. Ensuring a proper internal control process mitigates any kind of risk by creating a system involving checks and balances within the accounts payable department of the organisation, a system that monitors the data entry control system, payment entry control system and the obligation to pay control system. Each of the following internal control systems should be in place and work properly to keep payments safe and avoid any human error from within the organisation.

Conclusion

Money owing by a corporation to its suppliers and listed as a liability on the balance sheet is known as accounts payable. It differs from liabilities for notes payable, which are obligations made by formal legal instrument documents.

Accounts payable should have a credit balance because it is a liability account. The credit balance shows how much a business owes its suppliers. Because you owe money to creditors when you order products or services without paying for them in full in advance, accounts payable is a liability.

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FAQs

Q: Why is the management of accounts payable important for an organisation?

Ans:

The following reasons support the need of managing accounts payable:

  • Any type of purchase that allows for payment at a later time necessitates a sizable initial outlay to cover the balance owed. The business must therefore handle this effectively.
  • The sum payable on a particular date shall be payable on such particular date or before the payment due date. Delayed payments could result in negative word-of-mouth from the company's external stakeholders in the market, which would erode the reputation of the enterprise.

Q: State the key steps involved in the accounts payable process.

Ans:

The key steps involved in the accounts payable process are:

1. Capturing invoice

2. Approval of invoice

3. Authorisation of payment

4. Execution of payment

Q: What are accounts payable on a balance sheet?

Ans:

Accounts payable are shown on the liability side of the balance sheet. Accounts payable is stated as a line item in the current liabilities section of the balance sheet.

Q: What kind of account is accounts payable?

Ans:

Accounts payable is a liability account, not a business expense or an expense account.

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The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.
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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.