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Explaining the Accounts Payable Process

written by: madel57•edited by: Linda Richter•updated: 11/26/2010

How does the accounts payable process work? Miss Moore tells of an old theft. "Against accounts payable, Miss Moore?" asks Mr. Smith, operations manager. "The culprits must have been trusted people and the company must not have had a well guarded accounts payable process! It will not happen again."

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    What Happened at Rose Enterprises Five Years Ago?

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    The operations manager of Rose Enterprises, Mr. Smith, listens to his accountant, Miss Moore, as she narrates what happened five years ago before she was hired as accountant. During that time, the company was just starting and Mr. Borromeo trusted two persons in running the business: Susie, the accounts payable supervisor who was also a relative, and the ambitious Mr. Stan Horne as the operations manager. Management was never serious about the installation of systems, including the accounts payable process.

    Miss Moore says, “Stan opened a business account at his local bank in the name of Rose Enterprises, Inc. He deposited $100 and told the bank that the company had given him the authority to do so by showing some documents to them. Using his home computer, Stan printed bogus invoices in the name of the company. Susie, his lover, created a vendor record for the company on the company’s computer and put the bogus invoices in a stack of much larger invoices for payment and approval. This scheme continued for a year and netted a whooping $100,000 for the couple. Stan’s wife became suspicious and called the organization’s internal auditor, who tracked down the fraud."

    Miss Moore further states, “It is really imperative that we maintain safeguard measures for our accounts payable process. The incident will happen again if the company will not be concerned with this area. Aside from that, our clients are growing in volume and the president is contemplating a build-up of an online customer database."

    "It will not happen again, Miss Moore," assures Mr. Horne.

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    What is Accounts Payable? How Is This Classified in the Financial Report?

    Accounts payable is a file or an account ledger that records amounts that a company owes to suppliers of goods when payment has not yet been made. In the case of a trading company, payables are referred to as trade payables. When a credit invoice is received, it is added to the file, and then removed when it is paid. Thus, the Accounts Payable is a form of credit that suppliers offer to their customers by allowing them to pay for a product or service after it has already been receivedobjects00008g .

    Accounts payable is placed as a current liability in the financial standing report which we call the balance sheet of a company. Since it is classified as a current liability, it is settled by the company's current assets. A supplier usually offer discounts to his clients for prompt payment. However, there are some cases wherein a client prefers to forego discounts in lieu of the anticipated higher returns from the funds intended for paying his liabilities. This happens when, instead of paying the liability within the discount period, the client invests the funds in other activities that give him higher returns compared to the amount of the discount that he can avail by paying the liability within the discount period.

    Please turn to page 2 for more on the accounts payable process.

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    In page 2 of this article on the accounts payable process, the author describes that with a computerized accounts payable processing system known as the Systems Applications and Products process, there is a matching of the purchase order, the invoice, and the shipping receipt, step 1.1 of the SAP process. Step 1.2 of the process occurs when invoices are paid.
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    What's the Accounts Payable Process Designed for Rose Enterprises?

    Assuming that the goods ordered from a supplier are received, the accounts payable is established by the following steps:

    The validation of vendors’ invoices is done after receiving the invoices from the vendor. A vendor’s invoice is a business document that notifies the purchaser of an obligation to pay the vendor for goods that were ordered by and shipped to the purchaser. To follow the flow, let us label the validation of vendors’ invoices as process no. 1. Under process no.1, there are two important steps to follow: The two steps are named process 1.1 and 1.2.

    Process 1.1 comprises a number of steps: Upon the receipt of the vendor invoice, it is matched against the vendor database to determine that the invoice is from an authorized vendor. The invoice is compared against the purchase order database to make sure that there is a P.O and that the invoiced items, quantities, and prices conform to the purchase order. Then, the invoice is matched against the receiving report data to determine that the items and quantities that have been received are the items that were ordered and supported by a purchase order. The authorization of the purchase can be verified from the purchase order document. Finally, the invoice is checked for accuracy for items, computed discounts, if any, extensions of figures, and the total amount due. At this point, the vendor database is updated to reflect purchase history data.

    If the data items--the items themselves, quantities, and prices--do not agree, the invoice is rejected and follow-up procedures are initiated. If the items agree, the invoice is approved, and the validated invoice is sent on to the next step (1.2) to record the payable.

    If we have the SAP (Systems Applications and Products) system, just like what Rose has installed, we may open the window where the purchase order data is displayed. A match is performed for invoice verification to determine that the purchase order, goods receipt, and invoice all match within the tolerance chosen by the user.

    The accounts payable process can be continued with the payment process wherein fraud might be possible. Rose Enterprise’s payment process begins with the preparation of a list of payments that might be made at this time. The selection of this list is based on payment due dates and terms that may indicate that a discount can be taken for a payment at this time. The list should be reviewed and amended, if possible, for additional invoices that are not due for payment that can be made with other payments to a vendor.

    Please turn to Page 3 for more on the accounts payable process.

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    To achieve an effective accounts payable process, invoices must be processed in a timely and accurate fashion. If the company appropriately chooses what system is applicable to its operations, it can gain competitive advantage because of is efficiency in handling its disbursements.
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    Objective of an Efficient Accounts Payable Process

    The objective of a good accounts payable process is to have a timely, accurate, and efficient control of processing invoices for the payment of bills. An effective system also allows management to analyze expenses in order to avail discounts. The opportunity for discounts is one way to improve cash flow while maintaining relationships with suppliers. Timely means that a payable is prepared on time for its scheduled payment to avoid delay. Payment done after due date is charged with certain fees. Efficient means that there is the avoidance of waste. This means that assets are used efficiently. Accuracy connotes that payables are computed correctly. The success of doing these three tasks can be achieved if controls are integrated into the system.

    Going back to Rose Enterprises, the line-by-line comparison among the vendor invoice, the purchase order, and the receiving report is one strong control in validating the account with the supplier. This line-by-line checking is called a a three-way match. The data from the purchasing process is used to authorize the recording of the invoice. To obtain an independent validation of vendor invoices, the authority to record these invoices should come from the purchase order or receiving data entities and not from the department that prepares the payment for payables which the company is also integrating into the system. This procedure will eliminate the possibility of including unauthorized and invalid accounts payable records.

    The company also implements a user control wherein users make independent reviews of their respective output.

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    Conclusion: How Important Is the Accounts Payable Process to a Company?

    The objective of an accounts payable processing system is the installation of a processing system for disbursement transactions wherein the limited resources of the company are used for their settlement.

    Depending on the need, capacity, and appropriateness, the company installs either a manual or a computerized accounts payable processing system. The important thing in the system is that it must be integrated with appropriate controls.

    With the increased volume of transactions, it is right for Rose Enterprise to computerize its system in order to minimize errors, address probable client complaints, and improve its efficiency. The installation of appropriate controls is also made to avoid the occurrence of theft like that which happened five years ago.

    Book and Image Credits:

    Accounting Information Systems by Gelinas and Dull 6th Edition 2008

    www.freedigitalphotos.co.uk computerappletalkplug

    www.freedigitalphotos.co.uk objects00008gk