What is Accounts Payable? (Definition, Process & Examples)

Accounts Payable (AP) Definition

Accounts payable reflects the amounts owed by a company to its creditors or lenders, usually suppliers or vendors of specific products or services. Accounts payable AP refers to a company’s obligation to its suppliers – it’s a formal documentation warranting payment from the buyer, mostly a business in a contractual agreement with a supplier or vendor.

In collecting debts or monies owed for specific services or products, a supplier sends an accounts payable invoice to the AP department. The accounts payable invoice seeks to collect funds for rendered services or products.

The accounts payable department provides clerical, administrative, and financial support to an organization. The AP department is responsible for managing the end-to-end process of accounts payable. The AP function is a critical role of the accounting department. It involves approval, review, payment, and reconciliation of vendor invoices.

Accounts Payable (AP) Process

Creating a guide to AP procedures, steps, and best practices helps to improve the sourcing process and minimizes risks. Adopting AP automation solutions can help to reduce costs and improve the efficiency and transparency of the procurement process.

A comprehensive accounts payable AP guide should describe the accounts payable process as follows:

• Receive the vendor’s invoice and conduct a three-way matching process of vendor’s invoice, goods received notes GRNs, and purchase order PO.
• The accounts payable department approves the delivery of products or services to make payments.
• The accounts payable sends an invoice to the buyer if variances occur in the invoicing, such as differences in prices or quantities. The buyer works to find the source of the problem.
• Payment and checks are issued promptly after addressing the differences and variances. Payments are made after the invoice is vouched by the AP department.
• The invoice is marked as paid in the payment or financial system once the payment is issued.

The End-to-End AP Process

The AP process goes beyond simply creating invoices and settling them. The AP process is a strategic, end-to-end process of ensuring that products are delivered, verifying invoices, making payments, and marking payments as ‘completed’ in the financial system.

Accounts payable refers to all the payments that an organization makes, of course, except payroll. It’s critical to be accurate in vendor payment maintenance to avoid problems or losses.

The main goal of any AP process is to pay accurately for received goods or services with accurate invoices. The AP function seeks to make legitimate and accurate payments to correct accounts (what the company ordered, what it received, terms, quantities, accurate costs, etc).

In addition, the AP function seeks to find cost-saving opportunities through dynamic discounting and early payments. So, alongside settling accurate and legitimate invoices, the AP department aims to achieve cost savings through discounting and early payment.

AP automation has been proven as a creative solution to improve invoicing. AP automation establishes internal control to avoid fraudulent or inaccurate invoices – and ensures that all invoices are accounted for. AP automation solution proves to be a critical frontier in invoice harmonization efforts, especially vendor invoices.

The accounts payable process may differ from organization to organization. However, the cycle of events or steps includes:

• Receiving the bill or invoice from the vendor. The vendor sends a formal invoice containing the number of products or services ordered, the quantities delivered, and the amounts due.
• Verifying the data. The accounts payable department verifies the vendor’s invoice using a three-way matching process – purchase order, goods received notes, and supplier’s invoice.
• Updating the records. The AP department updates its payment systems to ensure that the invoice is recorded into the system and the invoice is scheduled or queued for payment.
• Make timely payments. It’s the buyer’s obligation to the vendor to make timely payments. Buyers must honor the contract’s obligation to make timely payments.
• Closing ledger account. The final step of the AP process is to close the ledger account for this particular transaction. Every purchase made by the organization is recorded in the financial system and saved as ‘completed’ or ‘closed’. Closing the ledger account helps with future ordering processes.

At the end of the accounts payable process, the amounts due as ‘payable’ won’t be a liability. Rather, it will be an asset because the vendor or supplier will look forward to doing business again with a trusted buyer. In addition, vendors may send discounts or offer to the buyer in the future.

Accounts Payable (AP) Examples

Example 1

When we consume internet, electricity, gas, or broadband, the bill or amounts due get generated at the end of the month or a given billing period. This bill implies that the service provider gave you some service and requires it to be paid. The vendor sends an invoice. This invoice must be cleared within a certain date. Failure to clear the amounts due will lead to an automatic default. Defaults will incur charges or the service will be disconnected. The amounts due for a service rendered – internet, television, broadband, or electricity – are known as accounts payable AP.

Example 2

When company A orders computers and laptops from company B on credit, both companies create different documents. Company A creates an account payable while company B creates an account receivable. Company A has a financial obligation to company B for the rendered services and products.

So, accounts payable simply means that company A owes company B certain amounts for products delivered or services rendered – and that these amounts must be paid within a certain period. Under the accounting methodology, services rendered or products delivered to a buyer are recorded as actual sales even though payments are yet to be made.

In this case, time is important when you consider that payments have to be made within a specific period. Alongside time is accuracy. Accuracy is critical because it shows the amounts due to the supplier and the supplier’s name. Accuracy will impact a company’s financial position.

You can contact ProcurePort for Accounts Payable AP automation solutions.