What are Accounts Payable?
During the normal course of the business, several different transactions are completed on a credit basis. This means that the company purchases goods at an earlier date, and then pays the supplier at a later date, after mutual consensus. When this happens, the company is said to have purchased goods on credit from the suppliers.
When organizations deal on credit, it arises in either a Current Asset or a Current Liability. In case the company sells goods on credit, it results in the creation of Accounts Receivable. On the other hand, when companies purchase goods on credit, it results in the creation of Accounts Payable.
Therefore, Accounts Payable can simply be defined as the Current Liability that arises for the company as a result of goods that have been purchased on credit. This is the amount that needs to be paid for goods and services that have already been received by the company.
Accounting Treatment of Accounts Payable
As mentioned earlier, it can be seen that Accounts Payable is referred to as a Current Liability. It arises when the company has purchased goods, but the payment has not yet been made to the supplier. In order to reflect the purchase of goods on credit, the following journal entries are made:
Purchases are debited to the Income Statement, whereas Accounts Payable have a credit balance in the Balance Sheet.
Once the payment has been made to the supplier, the following journal entries are made:
The aforementioned journal entries show the credit to the bank account and subsequent removal of Accounts Payable from the Balance Sheet of the company.
What is Accounts Payable Reconciliation?
Accounts Payable Reconciliation is referred to as the process undertaken by accountants in order to ensure that the balances listed under the Accounts Payable are accurate, and are representative of the actual accruals that are owed by the company.
During the normal course of the business, there might be a plethora of credit transactions resulting in the creation of Current Assets and Current Liabilities.
Since these accounts are carrying accounts, the chances of error within these accounts are marginally high. Therefore, accountants within the organization carry out Accounts Payable Reconciliation in order to verify and reinstate the amounts that have been declared in the financial statements.
Accounts Payable Reconciliation Process
When executing accounts payable reconciliation, accountants undergo the following steps:
- Step 1 – Reconciliation of the Prior Period Balances
As mentioned earlier, the balances that are mentioned on the Accounts Payable records are carrying balances that are carried from one year to the next. It is important from the perspective of the accountants to ensure that the previous year’s balances, i.e. the opening year balances of the current year, are reconciled, and are accurate.
Therefore, as a preliminary step, accountants make sure that the amount for Accounts Payable at the beginning of the year is accurate by double checking last year’s purchases, and payments made to the suppliers.
Once there is a certainty that the Opening Balance of Accounts Payable is free from any material misstatement, the accountants can then move on to the next step, i.e. inspecting the current year’s journal entries.
- Step 2 – Inspection of Current Year Journal Entries
Once the previous year’s amounts have been reconciled, the next step in Account Payable reconciliation is to ensure that the journal entries for the current year are analyzed to check for any inconsistencies. This involves checking for all the journal entries, and ensuring that all the entries have been correctly posted in the financial statements.
In this part of the system, it is important for accountants to ensure that all credit purchases have been separated from cash purchases. It is important to do so because the journal entries for both, cash purchases, and credit purchases are different.
Segregating both helps accountants ensure that the amount for accounts payable at the end of the given period is accurate, and correct entries have been posted in the accounts of the company.
Hence, this step would ensure that all the current year information is correctly posted in the accounts, so that chances of discrepancy are minimized to a maximum extent.
- Step 3 – Additional Reconciliation Activities
It is also important to note the fact that any additional accounts payable for the existing period are adjusted in the current reporting period. This means that all entries that are posted towards the end of the year are properly adjusted in the year-end financial statements so that there is absolute clarity pertaining to the financial statements.
These additional reconciliation activities are mainly focused on ensuring that any changes, like Purchase Returns, or payments made towards the end of the year are properly adjusted in the accounting records. It includes all the steps that help towards reducing the variance between the actual accounts payable, and the accounts payable actually incurred by the company. Examples of additional reconciliation steps include the following:
- Verification that the accounts payable journal is correctly posted to the general ledger.
- Verification of the aged accounts payable report being printed after the relevant report is completed.
- Verification that the general ledger is set to the correct reporting period.
Is it compulsory for organizations to reconcile Accounts Payable?
Organizations are not required to reconcile accounts payable by law. Not reconciling Accounts Payable does not result in compliance-related issues for companies. However, it is still considered good practice to have a periodic reconciliation of not only Accounts Payable, but all other accounts as well.
Therefore, it is NOT compulsory for organizations to reconcile Accounts Payable. In fact, it is considered as a step towards achieving higher thresholds and benchmarks of stringent internal control. The chance of material misstatement in the financial statement is subsequently reduced as a result.
Importance of Accounts Payable Reconciliation
Accounts Payable Reconciliation holds tantamount value from the perspective of the company. The reasons why accountants undertake this reconciliation process is as follows:
- It helps companies to ensure that the correct value of accounts payable is mentioned in the financial accounts. Since accounts payable are Current Liabilities on the Balance Sheet of the company, accountants ensure that they are correctly mentioned since they impact the accruals of the company.
- Accounts Payable Reconciliation helps organizations to plan their cash flows: Accounts Payable normally need to be settled in a period of less than 1 year. Therefore, it is helpful if organizations have a better idea regarding their cash outflows, so that they can plan accordingly.
- From a shareholder’s perspective, knowing that the company has stringent internal controls in terms of reconciliation related process is also relieving, because it is a testament of the accuracy of the data presented in the financial statement.
- Since Accounts Payables impact the Current Liabilities, it also impacts important ratios of the company, including Quick Ratio, and Current Ratio. If this ratio is incorrectly calculated, it might hamper the decision-making ability of the investors.