Accounts Payable Process

Terminology Training
What is Accounts Payable?

Companies have to buy raw material for running their business. In most cases, companies
do not pay the suppliers (also called as vendor) immediately after the purchase. Instead,
they get credit from the supplier, which means the supplier allows them to make payment
after a period of time. This means, the purchasing company owes money to the supplier
from the date of the purchase till the date the payment is made. Money owed is called a
liability and this liability is called Accounts Payable.

What is AP Department?

All business organizations have to make payments to outside parties for day to day
transactions. This is done by the accounts payable department in most companies.

AP department makes payments to

Suppliers for raw materials
Suppliers of fixed assets
Payments to employees on their travel expense (T&E) claims.

What is Accounts Payable process?

The AP process is a part of the “Procure to Pay cycle” (or P to P cycle). The P to P cycle
starts with the identification of the need to buy a Raw Material and ends when payment is
made to the suppliers.
In this module, we are going to study the different players, documents and terms involved
in this cycle.
The P to P cycle begins with the production department raising a document called the
indent (also called requisition) instructing the purchase department to purchase the
required items.

What is an Indent?

A document raised by the production department (user department) requesting the

purchase department to do the required purchase is called an Indent. This is the starting
point in any purchase.
The indent consists of the following details:

 Description of the Item/Service

 Part Number, if applicable
 Quantity required of material (Unit of Measurement (UOM) can be No., Kg, Ton,
meters etc.)
 Approval from the Department Head
 Approvals from Finance Department (for budget)
Purchase Department:-

Medium & large scale companies generally establish a separate department to facilitate
purchases. The main function of the purchase department is to analyze the different
suppliers available in the market on the basis of cost, quality and delivery and place
orders on the best suppliers. The purchase department will have dedicated professionals
working on this process. The purchase department raises a document called as “purchase
order” on the supplier from whom it chooses to purchase.

What is Supplier setup?

Once a new supplier has been identified and approved, that supplier needs to be set-up in
the company’s records before transacting with him. Supplier set up is an activity through
which the company assigns a unique code to identify that supplier. In all the future
transactions with that supplier, the company uses this code (ID). Normally, the purchase
department will send the list of newly approved suppliers to the person creating the ID.
The supplier setup screen shows relevant details of this supplier such as

 Details of items that this supplies can supply

 Address of the supplier
 Bank details of the supplier
 Commercial terms agreed upon with this supplier (e.g. Credit period).
The purchase department cannot raise a Purchase Order unless it has a valid supplier ID
for the supplier.

What is a Purchase Order (PO)?

A company has to enter into agreement/contracts with the supplier for procuring goods on
the agreed terms. Such agreements/contracts are called purchase orders when the contract
is for procurement of physical goods. Purchase orders are raised by the purchase
department.

What information does the PO/WO contains?

 Name & address of the company issuing purchase/work order.

 PO Number & Date- The computer will generate a unique number for every PO
that is raised. This is called the PO number.
 Name/Address of the supplier.
 Description of goods or services ordered. For example while buying furniture, the
description can be “Round table with glass top” or “six feet cupboard”.
 Part number (if applicable) this is a unique number that is allocated to each item.
For example, “Round table with glass top” can be given a part number “020-555-
1892”.
  Quantity ordered along with delivery schedule, if any

Delivery schedule: While placing an order with a supplier, the customer gives the
delivery schedule. The delivery schedule gives details about dates on which the
goods have to be delivered.
Example, A PO ordering for 50 round tables with glass tops could give the following
delivery schedule.

3rd January 2008 20 Units

15th January 2008 10 Units
31st January 2008 20 Units

 Price: The price include relevant information on freight/ taxes/ insurance etc.
 Freight: It is the charges paid by the company for transporting the goods from
one place to the other place. The freight could be borne either by the supplier or
the customer depending on the agreement.
 Tax: A tax is a financial charge or fee which is imposed by different state or
central governments on sales transaction. The seller has to collect the tax from
the customer on behalf of the government and then pay that money to the
government.
 Insurance: There is always a risk that goods being sold could get damaged/lost
while in transit. It is a normal practice to insure the good while in transit. The
insurance cost could be borne either by the supplier or the customer depending on
the agreement.

‘Bill To’ and ‘Ship to’ Address

Various addresses of the customer and the supplier are mentioned on the PO.

Bill to address:
The customer’s address to which the supplier has to send the invoice is called as Bill to
Address.

Sold to Address:
The customer’s address from which the purchase order has been raised is called the sold
to address.

Ship to Address:
The customer’s address to which the goods ordered need to be shipped or sent by the
supplier is called Ship to address. It is the point of delivery of the goods as specified in
the purchase order.
Payment Terms:

Payment terms are the terms and conditions on which the payment will be made by the
customer to the supplier.
The main payment term is the “due date” of the payment. Payment terms often give an
option to the purchasing company to pay the invoice before the due date and take a
discount available for early payments.

Some commonly used terminology used to communicate payments terms is as below

 Net 30 – This means the buyer must pay within 30 days of date of invoice.
 2/10 net 30 – This means buyer must pay within 30 days of the date of invoice,
but will receive a 2% discount on the invoice amount if they pay within 10 days.

Receiving Department:

The supplier will ship the goods to the customer as per the PO specification. The
receiving department in the customer’s organization receives the goods and checks
whether the goods received are of the required quantity and quality as per the PO.

What is a Packing slip?

When the goods are received at the receiving stores, a document called the packing slip is
also received. The packing slip is prepared by the supplier. It lists down the actual
description and quantities of material being loaded on the truck. The packing slip will
also have the PO reference.

What is a GRN (Goods Received Note)?

The receiving department prepares a document called GRN (Goods Received Note) as
soon as it received the goods. The GRN has many columns. These columns will be filled
at different stages of the receiving process.
As soon as the goods are received, the “description” and “quantity received” columns of
the GRN will be filled.
The goods then go through an initial round of quality and other checks. Goods can be
rejected if they do not pass the quality and others checks. Other checks include checking
for late delivery, wrong description et. If any of the goods do not pass these quality or
other checks, they will be rejected and the “Accepted” and “Rejected” columns in the
GRN will be filled.

What happens to rejected goods?

If the goods are rejected, they will be sent back to the supplier by the stores department.
What is an inspection Report?

If the items purchased are of a technical nature, the items may have to undergo a
thorough technical test. On passing these tests, the quality department will prepare an
inspection report which will be used as a document for a four way matching (described
later in the notes)

What do you mean by exceptions in receiving?

Often, quantities received are different from those ordered. Companies set tolerance
limits to decide whether or not a particular shipment should be accepted when the
quantities differ. If the shipment is within the tolerance limit, it will be accepted.
Companies can have policies to set the tolerance limit. For example it will give the
instruction to the receiving department saying, if the shipment is + of – qty.2, accept the
shipment. In that case if the goods ordered are Qty 4 and received is Qty 2, the company
will still accept the shipment because it is within the tolerance limit set by the company.

Invoice Processing:

Once the ordered goods are dispatched, the supplier will send a copy of invoice for
payment to the customer. Sometimes, the invoice may be received along with the goods
and sometimes it could be received before or after the receipt of the goods.

What is an invoice?

An invoice is a commercial document issued by a seller to a buyer, indicating the

products, quantities and agreed prices for products or services which the seller has
already supplied provided the buyer. An invoice indicates that, unless paid in advance,
payment is due by the buyer and seller. Invoices are often called bills.
What details does an invoice contain?

 Invoice number and date

Invoice Number: It is a number or combination of numbers and characters that uniquely

identifies an invoice within the system. It is generated automatically by the system to
avoid duplication of numbers.

Invoice Date: It is the date on which the invoice is created.

 Purchase order number

 Tax ID number

TIN (Tax Identification Number): It is a unique 9 digit number assigned by the tax
department to business entities operating in the United States for the purpose of
identification. It is also known as EIN (Employer Identification Number). All entities
must have EIN to file the tax returns.

 “Bill to”, “sold to”, “ship to” addresses and “remit to” addresses

Remit to address: The supplier’s address to which the customer is asked to send the
payment is called the Remit to address.

 Terms of payment including due date, discount due date and discount amount.

Due date: It is the date on which a particular invoice becomes payable. For example, an
invoice may carry due date as 1st January 2008. That means, that invoice should be paid
on or before that date.

Cash Discount (Early payment discount): It is a reduction allowed on the invoice price
to the customer for making an early payment of the invoice. The word early means –
before the due date.

 Line-item: When more than one item is sold against one invoice, each of those
items has to be separately mentioned on the invoice. Since each of these items
will be shown on a separate line on the invoice, it is called a line item. Each line
will have details of description, quantity and price of the relevant item.
 Shipping method and cost: Shipping can be by road, air, sea or rail. The name of
the carrier / transporter will also be specified. The cost of shipping, if to be borne
by the customer will also be added as a separate line item in the invoice.
 Total number of items and sum of amount due: This summarizes the total amount
to be paid to the supplier.

What are Invoice Processing / Matching?

Before making the payment on an invoice, it is necessary to check whether or not the
invoice is in order. There is a need to match the invoice with other relevant documents,
i.e., PO and the GRN. If the documents match, payment is to be made to the supplier,
else the case has to be investigated and resolved.

What is a tolerance limit (Invoice Processing?)

Sometimes, there could be minor differences in the invoiced amount and the amount as
calculated as per the PO. In such cases, many companies have a policy that the full
payment as per the invoice should be made provided the difference between the two
amounts in not more than a specified dollar amount. This is called the tolerance limit for
invoice processing.

What are the difference ways of matching?

It is possible to carry matching in various ways. These are called two way matching,
three way matching and four way matching.
Two way matching:
It is the process of verifying the purchase order information with the invoice information.
The PO and invoice should match within the acceptable tolerance limit to make the
payment. AP department does the following tests in case of a two way matching.

Is Invoice Price=Purchase Order price?

Is Quantity billed=Quantity ordered?

Three Way Match?

It is the process of verifying whether the PO, invoice and receiving information (GRN)
matches within the acceptable tolerance limit or not. In three way match, typically,
quantity and price as per PO with quantity and price as per invoice and quantity received
as per the GRN are compared. The following criterion is used by the AP department.

Is invoice price=purchase order price?

Is Quantity billed=Quantity ordered?
Is Quantity billed=Quantity received?

Four Way Match

It is a process of verifying whether the PO, invoice, GRN and also the acceptance report
(Inspection Report) matches within acceptable tolerance limit or not. This would be done
in case of material that is of a technical in nature and which has a strict quality
requirement. Payable uses the following criteria to ensure the four way match.
Is Invoice price=Purchase order price?
Is Quantity billed=Quantity ordered?
Is Quantity billed=Quantity received?
Is Quantity billed=Quantity accepted?

What do you mean by Invoice on Hold?

An organization may not pay all the invoices which have come for the payment. Such
invoices are said to be invoice on hold. The payment against such an invoice will be
made only after the hold on the invoice is removed. The reasons for keeping an invoice
on hold are:
 Missing invoice number
 Invoice is not clear

What is a NON PO invoice?

Non PO invoices are the invoices issued for utility bills such as Rental Charges, Water
bills, Telephone bills, Electricity charges. They are also used in case of services where no
WO is raised.

While making payment against Non PO invoices, approval from designated authority is
very important. This is so because, unlike in a PO invoice, there is no prior approval of
the expenditure. That is why these invoices are sent for approval before payment. Since
there is no PO for these invoices, no matching is carried out. They are paid on the basis
of the approval of the authorized person.

Payment:

Once the invoices are processed it will be sent for the payment. Payment can be effected
in one or more of the following ways. The mode of payment is agreed upon at the time
of the contract.

Check payment:

Check is a negotiable instrument drawn on a bank for making payment to a specified

supplier. Checks are the most common mode of payment.

Check run:

Check run process is a program which is run periodically to print all the checks that are
due for payment during that period.
Frequency of check runs depends upon the business policies. It can be daily, once or
twice a week, once in two weeks or so. Some time special check runs are there to pay
urgent\past due invoices.
Note – Payments will be made on the run date immediately after the due date. If cash
discount is available on an invoice, payment can be made on the last date on which
discount is available. In exceptional cases, payment can be expedited if a special request
is made by the vendor and the case is approved by authorized persons.
Electronic Fund Transfer (EFT)
Electronic Fund Transfer (EFT) is a system of transferring money from one bank account
directly to another without any paper money changing hands. In other words EFT
includes any transfer of a fund that is initiated by electronic means, such as an electronic
terminal, telephone, computer, ATM or magnetic tape.

Two categories of EFT are Wire Transfer & ACH

Wire Transfer:
A wire transfer is an electronic transfer of funds. Under wire transfer, transfer of funds
takes place from the customer’s bank account to the supplier’s bank account
electronically. Customer will give a wire message to his bank to transfer the funds to the
supplier’s account. It is used for both domestic and international transfer of funds.
Under wire transfer payment no cash or cheque exchange is involved, but the account
balance is directly transferred from one bank to other.

To enable wire transfer, a supplier should choose wire transfer as the mode of payment
and also provide their banking details at the time of setup.
ACH (Automated Clearing House):

It is a secure, private network that connects banks by way of the Federal Reserve Board
or other ACH operates. It is a batch oriented EFT system governed by the NACHA
which provide for the interbank clearing of E-payments for participating financial
institutions. A receiver authorizes an Originator to issue ACH debit or credit to an
account. The Originator then creates an ACH entry to be given to an Originating
Depository Financial Institution (ODFI), which can be any financial institution that does
ACH origination. This entry is then sent to an ACH Operator (usually the Fed) and is
passed on to the Receiving Depository Financial Institution (RDFI), where the Receiver’s
account is issued either a credit or debit, depending on the ACH transaction.

Direct Deposit:

Direct Deposit the electronic transfer of a payment from one account to another account
without any paper document. Another name for direct deposit is GIRO.
Direct Deposit differs from check payment. A check is given to the payee who deposits
the same in his or her bank; a GIRO is given by the payer to his or her bank. The bank on
receiving the GIRO transfers the funds into payees account directly.
The instruction could be for one payment or for recurring payments. Eg. A company can
give a GIRO to a bank instructing it to directly transfer $1000 to the account of a lessor
who has leased office premises to the company.

P-Card

P-Card refers to a purchasing card. It is an enhanced credit card issued by a banking

organization and given by a business entity to its employees. Authorized personnel can
make small purchases of goods & services using P-card. P-cards can only be used by the
individuals named on the card. After the individual makes purchases using the P-card,
the issuing authority gets the information on the purchase made & sends the bill to the
company. Once the company receives the bill from the issuing authority, it will verify the
purchases made and the payment will be sent directly to the bank.

Evaluated Receipt Settlement:

ERS is a procedure for the automatic settlement of invoices which does not require any
matching of invoices.
In ERS the purchaser will have an agreement with the supplier directing the supplier not
to send an invoice for the goods supplied. The purchaser will post the payment directly
based on the information contained in purchase orders and the electronic packing slip.