Accounts Payable - Week 1 PDF

ACCOUNTS PAYABLE WEEK 1- Some Accounting and Bookkeeping Basics, Invoice Handling The Three- Way Match and More & Payment Issues SOME ACCOUNTING AND BOOKKEEPING BASICS In order to fully understand why matters are handled the way they are in accounts payabl...

ACCOUNTS PAYABLE WEEK 1- Some Accounting and Bookkeeping Basics, Invoice Handling The Three- Way Match and More & Payment Issues SOME ACCOUNTING AND BOOKKEEPING BASICS In order to fully understand why matters are handled the way they are in accounts payable, it is a good idea to know a little about accounting and bookkeeping. Much of what is done in the department has strong accounting implications. By understanding basic accounting and bookkeeping as they relate to accounts payable, associates will instinctively understand the reasoning behind certain actions. They will also be able to avoid common mistakes that arise from a lack of understanding of the difference between debits and credits. Remember, accounts payable is a lot more than just paying bills. What is Bookkeeping? Bookkeeping is the first step—the recording of all activities and transactions. It is the first step in the accounting cycle. In fact, some of the processes that are commonly referred to as accounting are actually bookkeeping. For example, balancing a checking account statement is actually a bookkeeping function, although it usually falls under the accounting umbrella. Many consider gathering backup information, such as is done in the three-way match, a bookkeeping function rather than an accounting function. What is Accounts Payable? The accounts payable figure on the financial statements of any company represents the company’s unpaid bills. It is the money owed by the company to its suppliers and other creditors. Accountants break the money owed by the company into two groups: current liabilities and long-term liabilities. They consider accounts payable a current liability. Current liabilities are those obligations that must be paid in less than one year. Other current liabilities might include taxes and salaries. These are separated from items such as long-term debt repayments that have longer due dates. Liabilities A company’s liabilities are its obligations. They include items such as bank loans, money owed to vendors (also known as accounts payable), employees’ salary, and any other expenses that might arise from the business operations. Typically, liabilities are broken into two categories: short term and long term. Short-term liabilities are typically those that must be paid in the next 12 months while long- term liabilities are those that are due after 12 months. Thus, accounts payable is almost always a short-term liability. Interest on bank loans is typically considered short term while the principal repayment is classified as long term—until the year they become due. Assets The opposite of a company’s liabilities are its assets. One hopes to work for a company whose assets exceed its liabilities. For accounting purposes, the company’s assets are everything it owns. These, too, are broken down into two groups: current and fixed. Current assets are items that can be converted to cash rather easily. They include accounts receivable, inventory, and prepaid rent. Fixed assets are items that are generally not held for resale purposes. This includes items like machinery, real estate, and furniture. Although it is true that most of these items could be turned into cash, this could not be done easily, so they are not considered current or liquid assets. When analysts look at assets and liabilities, they not only study the relationship between the two, but also look closely at the comparison between current assets and current liabilities. If current liabilities exceed current assets, there can be serious financial consequences. Expenses Expenses can be classified several ways: Pre-paid expenses are monies paid in advance for a product or service. They are actually considered an asset until the expense is incurred. The most common pre-paid expense is insurance, which can sometimes be paid as infrequently as annually. Current expenses are expenses that have been incurred (and thus are considered a liability) and will be paid within the current period. Accrued expenses are expenses that a company has incurred but has not been billed for yet. Many companies accrue accounts payable expenses at the end of each month and virtually all accrue them at the end of the fiscal year for financial statement purposes. It is not uncommon to hear accounts payable associates talking about doing accruals at month end. Expenses Using accruals allows the company’s executives and bankers and— in the case of public companies, its investors—to have a realistic picture of the company’s financial position and obligations. These numbers can be especially meaningful in the case of those companies that employ payment timing or stretching practices. Accruals Accounts payable associates will sometimes indicate that they are doing accruals. As just indicated, this is usually done at the end of some sort of a reporting period. Typically, what the associate is doing is calculating the expenses that have been incurred but for which no invoice has been received. This is not done in every accounts payable department but is performed in many. Chart of Accounts When accounts payable associates record information, they must have a category with which to associate the information. To do this, most companies assign a reference number or an account number. The list of all these account numbers is called the chart of accounts. It is sometimes referred to as the index of the general ledger. Each company develops its own chart of accounts. The number of accounts is limited only by the imagination of the company’s accountant and the company’s detail requirements. There can be as few as 50 accounts for a small company, or many more. A few nimble accounts payable associates end up knowing the account codes of their most common transactions by heart and rarely refer to the chart of accounts. General Ledger The entire chart of accounts for a particular company and all its related information is called the general ledger. It is referred to in accounting literature as the GL, sometimes written G/L. It is the information pertaining to the actual accounts, and great care is given to who has access to it and who can update information in it. In fact, there is often great debate about outside information being fed directly into the G/L. Some auditors recommend against this unless strong controls monitor the outside input. Others prefer these updates be done to some sort of a suspense account, with the company doing the update after the outside information has been reviewed. Debit and Credit Memos This area sometimes leads to confusion in accounts payable—the results of which can be pretty strange. A debit memo is a convenient way of letting a creditor know that the company wants to debit the vendor’s accounts payable account for a return, a price reduction, or some other matter. In an ideal situation, the creditor will confirm this reduction by issuing a credit memo. As you might have guessed by now, reality is not always so smooth. Sometimes, the supplier will realize it was overpaid and issue a credit memo—which it doesn’t give to the customer. The credit balance sits on the account. Eventually, the vendor may simply write off the amount, never giving it to the customer. Debit and Credit Memos In the worse-case scenario, the vendor does send the credit memo to the customer and the accounts payable associate, not understanding debit and credit memos, pays the credit memo. Now the company has double paid the vendor an amount it never owed in the first place. This, unfortunately, is not an uncommon occurrence, and is one of the reasons accounts payable associates need to understand rudimentary accounting. Sometimes you will see debits abbreviated as dr. and credits as cr. The abbreviations come from the Latin terms from which the terms are derived, debere and credere GAAP Companies are under great pressure to produce the best possible numbers in their financial statements. If there were no guiding principles, some might be tempted to fudge the numbers. To make sure their statements meet regulators standards, companies must complete their accounting using generally accepted accounting principles (GAAP) standards. This also makes it possible to compare financial reports from one company with those from another. Expect to hear about financial statements prepared using GAAP or according to GAAP guidelines. The goal of GAAP is to prevent companies from using a variety of creative accounting techniques to make the numbers look better than the company actually does. Audit Trails Accountants are famous for talking about audit trails—and with good reason. They make a lot of sense.Whenever possible, make it very clear why and how certain actions were taken. For example, if an invoice is to be short paid, indicate the reason in the file. To make the issue even clearer, some companies pay the entire original invoice and then issue a debit memo to cover the difference. The exact methodology is less important than making the reasoning clear to anyone who comes along. Putting a note in your files might work for the accounts payable department, but if that information is not available to others who might need it, your audit trail might not be very clear. Suspense Accounts Sometimes it is not clear to what account an item should be booked. Rather than delay the processing of the item, it is booked to a suspense account to be researched further at a later date. The theory behind suspense accounts is that they allow the work to proceed and are to be cleaned out shortly when the proper accounting is determined. However, researching items in a suspense account is not at the top of anyone’s list, so items often stay in suspense much longer than the company’s accountants and controllers would like. Left up to their own devices, many professionals would not use suspense accounts. However, they are a necessary evil if one wants to run an efficient accounts payable department Invoice Handling: The Three- Way Match and More In this section we’ll look at: The documents needed to make a payment Knowing the proper procedures for handling invoices Identifying the problem areas related to invoices Handling problem invoices Using statements correctly Invoice Handling: The Three- Way Match and More At the very lowest level, accounts payable’s chief responsibility is to pay a company’s bills. On the face of it, this might seem simple, but it is not, really. Those who say, "What's the big deal—you get a bill and then you pay it,” show no understanding of the corporate accounts payable world.Yes, accounts payable pays the bills—but no, the staff does not just get a bill and pay it. It only does so when proper controls are in place and when the payment is approved. Payment Processes Three documents normally govern a corporate payment: the invoice, the purchase order, and the receiving documents. We will look at each of these in detail in this section. Invoices Simply put, an invoice is a bill. Invoices can be simple or complex. For example, a bill for a magazine subscription usually has one item on it and is pretty straightforward. Now, think about a credit card bill. If your credit card bills are like mine, they have many charges on them. Each item purchased is listed separately so you can identify the goods you bought. In the business world, a bill is known as an invoice, and each of the lines representing an individual purchase is referred to as a line item. Invoices In addition to information about what was purchased, the invoice will ideally contain this information: Where to send the payment When the payment is due What the payment terms are; that is, whether a discount is available if a payment is made early Any special instructions Invoices Unfortunately, all invoices are not the same. Not all invoices spell out the required information clearly, and certainly not all companies use the same format. Worse still, many invoices are confusing, and a few are even misleading. Thus, one of the many roles of the accounts payable department is to check the invoice to see that it is accurate. One of the common methods for judging performance of accounts payable associates is to measure the number of invoices processed in a given period of time. Since one invoice may have one line item while another can easily have hundreds, this method of comparison leaves much to be desired. Even those companies who have taken the measurement concept to a more reasonable level and measure line items processed instead of invoices can run into trouble. Why? Some invoices, regardless of the number of line items, are easier to process than others Invoices Some companies are good at preparing clear, accurate invoices, while others are not. After you have worked at a particular company for a while, you will come to know which vendors provide easy-to-process invoices and which vendors should be avoided like the plague. Purchase Orders The purchasing department sends a purchase order (PO) to the supplier when ordering goods for the company. Ideally, it will show not only all the details relating to the purchase (i.e., quantity, price, and so on), but also any special terms that the buyer may have negotiated. All too often, the purchasing department negotiates a great deal and then forgets to notify the accounts payable department. Then, when the vendor “forgets” to use the negotiated price and sends a bill with the original price, accounts payable has no way of knowing and ends up paying the original price—so much for the great negotiation. In an ideal world, the purchasing department would send along a copy of all completed purchase orders to accounts payable. In reality, accounts payable does not always receive copies of purchase orders. Also, in many organizations the PO is not completely filled out, so even if accounts payable receives the PO, it does not have all the information it needs to verify purchases. Receiving Documents Before paying an invoice, most companies want to make sure the goods were received. Additionally, they want to know whether everything that was ordered was actually sent. Thus, before paying the invoice, it would be imperative that the accounts payable associate knows the quantity received. The fact that the receiving documents are used in verifying information before a payment is made should put additional pressure on the staff that works on the receiving dock. However, some receiving departments don’t check the goods received against the receiving documents. Traditional Method of Handling: The Three-Way Match In an ideal world, where all documents were checked and completed and sent to accounts payable, paying invoices would be rather simple. The accounts payable associate would take the three governing documents— the invoice, the purchase order, and the receiving document—and compare the three. They would all agree and the invoice would be processed for payment. In reality, the first-time match rate (sometimes referred to as a first-time hit rate) at many companies hovers in the 50 percent area. That’s right—only half the invoices that come in for payment match the purchase order and the receiving documents. Many companies have first- time hit rates that are much higher. But if you ask accounts payable professionals in the trenches, they will tell you that the biggest problem is with the invoices. Traditional Method of Handling: The Three-Way Match In order for the vendor to be paid on a timely basis, all the documentation must be received in the accounts payable department in some sort of a reasonable time frame. This can be difficult if the invoices are sent willy-nilly all around the company. For this reason, some companies have a policy of directing all invoices to accounts payable. This works well if accounts payable either has a purchase order for the invoice or knows who placed the order. If not, it is a real problem. Where to send the invoice also revolves around the approval issue. Approvals of Invoices In theory, if all the documentation is filled out correctly and if it all matches, the accounts payable department should be able to pay the invoice without input from any other party. However, few companies are at this point. Even at those companies where the documentation is good, management often demands that the original purchaser get involved and approve the invoice for payment. Why? That’s a good question. Getting approvals on invoices before payment can lead to a multitude of problems. The following is just a few of the things that can go wrong: Approvals of Invoices The invoice is not addressed to anyone in particular and floats around the company, eventually landing on the desk of the right person. In the meantime, the vendor looking for payment makes several calls to the accounts payable department, forcing an accounts payable associate on a wild goose chase looking for the missing invoice. The invoice is missing for so long that the vendor eventually sends a second one addressed to the accounts payable manager, who immediately forwards it to the appropriate party for approval and then speedy payment. Eventually, the initial invoice shows up, is approved, and is sometimes paid. Thus, eventually the vendor gets paid twice—not a bad deal for the vendor, but not such a good option for the customer. Approvals of Invoices The invoice is sent to the accounts payable department, which forwards it to the approver. This usually entails making a copy of the invoice, keeping a log of who was sent what, and when it was sent. If the approver is not a details-oriented person, the approval of invoices is likely to be a low-priority task and the invoice can sit waiting for approval for weeks. At least in this scenario, the accounts payable associate can identify where the invoice is when the irate vendor calls. Invoices are directed to the original approver, who then forwards them to accounts payable with the necessary approvals ready for payment. Approvals of Invoices All of these approaches are common in businesses today. Leading- edge companies insist on complete documentation, and some allow payment, without further approval, if the three documents match. Companies that use imaging and workflow are starting to bring that technology into their accounts payable departments. In these companies, all invoices are sent to the accounts payable department, where they are imaged—scanned and turned into a computer-readable attachment. The invoices are then forwarded using workflow technology and e- mail to the appropriate person for approval.With the approval in place, the invoice is then returned to accounts payable for payment, assuming, of course, no discrepancies. Who can approve? At most companies, only certain people can approve invoices for payment. Most companies limit this ability by rank, job responsibility, type of purchase, and sometimes even the dollar amount. In the best of circumstances, the board of directors should have given these approvers authority and accounts payable should have copies of these board authorizations. You notice we said, in the best of circumstances. Not all companies are this organized. However, even if there are no board authorizations, accounts payable should have a list of who can approve what purchases. A high level executive at the company should sign off on this list. Otherwise, it is exceedingly easy to have fraud, and accounts payable could end up taking on a responsibility it should not. Copies of the list should be given only to those who need it, and in all cases should be filed away carefully. The list should not be hung on the wall for easy reference or Who can approve? left lying on a desk where anyone walking by could see it and easily make a copy. When the list is updated, as it periodically will be, old copies of the list should be destroyed. If you want to be super careful, new copies of the list should only be exchanged for the old ones, and all the old ones can be destroyed together. Signatures Just because an invoice arrives in accounts payable with a senior executive’s signature on it does not mean that the senior executive actually approved the invoice. To protect the accounts payable staff, the department should have signature cards in accounts payable containing the actual signature of anyone authorized to approve invoices. And, it should be the executive’s real signature—the one he or she uses everyday and not the Sunday-school signature. We are not suggesting that these cards be checked for every invoice that shows up. However, spot checking once in a while is not a bad idea. And, obviously, if a suspicious-looking signature arrives on an invoice, the signature cards should be checked immediately. One accounts payable associate reports receiving an invoice with an illegible scrawl that could not be identified. After checking the signature cards and finding no match, she bounced the invoice to the secretary who had sent in the invoice. It seems that the treasurer, someone who rarely approved invoices, had approved this particular invoice. He was one of the culprits who had supplied his Sunday-school signature rather than his real one. Luckily, he was good-natured and re-signed a signature card using his real signature. However, more than one accounts payable professional has uncovered internal fraud by simply checking signature cards. Other Invoice Issues- Unidentified Invoices Often an invoice will show up in the accounts payable department with no identification as to who ordered the product. Sometimes by looking at what is included on the invoice, a savvy accounts payable associate will be able to figure out who the likely purchaser is and will then forward the invoice to that person for approval. However, that is frequently not the case, especially in the case of generic goods. Some companies simply return those invoices to the vendor, instructing the vendor to forward the invoice to whomever they shipped the goods. Their managers think that it is not the responsibility of their accounts payable department to play detective. This may be a good approach for another reason, and that is fraud. More than a few companies out there prey upon overworked accounts payable departments. They send along invoices for goods not ordered, knowing full well that these small dollar invoices will be paid without authorization. Invoices Without Invoice Numbers Most, but definitely not all, companies put an invoice number on all their invoices. This is a unique number and identifies that particular invoice. It is a critical number, as it is used as a reference by all parties involved. The vendor uses the invoice number to make the cash application when payment is received and the customer (that’s you) uses the invoice number to track the invoice, relate it to a particular purchase order, and—most importantly—to make sure that the particular invoice in question has not already been paid. When the customer goes through its computer files, it will search to see if the particular invoice number has been paid. Additionally, most accounting programs require an invoice number in order to generate a payment. So, invoices without invoice numbers present a real problem for accounts payable associates. To get around the issue, most companies simply assign an invoice number. This must be done with great care, or else the system will regularly dump out a large number of payments when any duplicate payment check programs are run. Invoices Without Invoice Numbers Using the date to assign an invoice number is likely to cause problems, as you will probably end up with duplicate invoice numbers.Some use a combination of the vendor number and the date.Again, this can cause trouble if you receive more than one invoice from the same vendor on the same day. Another ploy is to use a combination of the account number. Be careful with this if the account number bears any relation to the tax identification number or a person’s social security number. There have been instances where unscrupulous employees (yes, there are a few of those) have taken the social security numbers and used them in an unscrupulous manner. The best technique is probably to make up a dummy number that includes some unique identifier to the vendor—for example, a combination of digits from the vendor’s phone number and a running total. Summary Invoices Often a company will receive many small dollar invoices from the same vendor. In the case of an overnight shipping service, the number of invoices involved could be astronomical. In these cases, some companies request that individual invoices be suppressed and the vendor send one invoice summarizing the purchases for a given time period, usually a week or a month—hence, the term summary invoices. These are especially appropriate for shipping companies, office supplies, and temporary help agencies. Remittance Advices When most companies print their checks, they print identifying information on the accompanying remittance advice. The most important piece of information usually is the invoice number (hence the problem when an invoice has no invoice number). Now, this remittance advice is usually of no importance to consumers, but to companies it is vitally important. It gives the vendor the information it needs to apply the cash to the correct account. However, certain companies send along a stub with their bills. They require that this stub be returned with the payment. This is so the vendor can apply the cash payment correctly. The most common of these relate to utility bills, such as the phone or electricity bills. When you make your own utility payments, you typically include the stub with the payment so the utility company can apply the payment to your account. The utility company wants the same stub with your company’s payment. Unfortunately, this presents a problem for accounts payable. Many companies print and mail their checks without ever returning them to accounts payable. Some even have a machine that prints, signs, and seals the check. Thus, special arrangements must be made for checks that require special material to be included with the payment. When Invoices are short- paid When an invoice is paid for the exact amount, there is rarely a problem. The issue is that, unfortunately, it seems that invoices are rarely paid for the exact amount. Deductions are frequently made, for various reasons: Discounts for early payment Short shipments Damaged goods Advertising allowances Prior credits Over shipments Pricing adjustments Advertising allowances Insurance or freight incorrectly charged When Invoices are short- paid When the credit manager at the vendor’s office receives the payment, he or she does not know what the deduction was for. Inevitably, the invoice remains open because it has only been partially paid—at least in the manager’s eyes. The credit professional then calls the accounts payable manager, and an attempt is made to reconcile the difference.Unfortunately, by the time the call has been made, the accounts payable manager has long forgotten the reason for the adjustment and must pull the file to find out exactly what happened. A better approach is to include the reasons for the deductions with the payment. The vendor might not agree with all the deductions, but at least it will know the reasons for the reduction. Several companies include a checklist form that allows the accounts payable associate to check off the reasons for the deductions. This approach at least documents the cause and gives the credit professional the information needed to research the problem on the other end. Often, this simple form eliminates the problem completely. Blanket Purchase Orders When companies make the same purchase over and over again, say for office suppliers or rent payments, the need to complete a purchase order does not seem as relevant—to some. Some companies have taken to writing one purchase order to cover multiple purchases or payments. This is referred to as a blanket PO, and it generates a lot of controversy. People either love them or hate them. Often, corporate philosophy and culture will dictate whether they are used. Payment Issues Statements “Never pay from a statement” is usually good advice. However, that does not mean that accounts payable should not get statements from all vendors at least once a year. These statements should not be used for payment purposes but to track how the account is doing and to ensure that the accounts payable department has received all the invoices sent. When asking for statements, make sure that you insist that the statement show all activity. More than one crafty credit professional has produced statements that show outstanding invoices only. The main reason for getting statements, in addition to monitoring invoice activity, is to check for outstanding credits. Statements When these are identified, the accounts payable professional should ask for a check for these amounts. If the vendor is reluctant to write a check, and many are, then the credit should be applied to the next invoice paid. Receiving the payment is best, not only from a cash flow standpoint, but also because it is less likely to confuse matters later. If the credit is applied to an open invoice and a payment is made for the remainder of the invoice, con fusion could ensue. This is most likely to happen if the person handling the cash application on the other side is not proficient and records the payment as a partial payment. If the credit is to be applied to an outstanding invoice, make sure your documentation is clear. Include in your file any back-up documentation so when you are questioned about the matter 12 to 24 months later, you will be able to figure out what you did. A note about open credits A few accounts payable clerks with a weak understanding of accounting will actually pay a credit. Not understanding that the open credit is money owed to the company not money owed by the company, numerous accounts payable clerks have paid open credits. Invoice Due Dates Accounts payable professionals and their company’s vendors have conflicting agendas. Accounts payable professionals want to hold on to their company’s money for as long as possible while the vendor wants to get paid as quickly as possible. Sometimes credit professionals will make what they call a courtesy call to the accounts payable manager a week or so before the invoice due date. This is most likely to happen with large- dollar invoices. The purpose of these calls is to make sure that everything is in order and that the invoice will be paid on time—a reasonable approach. Invoice Due Dates The beauty of these calls, at least from the vendor’s perspective, is that any problems can be resolved before the due date and the payment can be made without interruption. Additionally, if the invoice hasnot been received, for any reason, a copy can be supplied and the payment can still made within the agreed upon time frame. Although some accounts payable professionals welcome these calls, others find them a nuisance and a few refuse to take them at all. Those refusing to take them typically work for large companies where there is a policy of not addressing any vendor issues until an invoice is 30 or more days past due. Invoice Due Dates A few enterprising vendors have taken these “courtesy calls” to a new level. They will call up and ask the accounts payable associate for a payment for an invoice they claim was due the prior week. Don’t necessarily believe everything you hear on the phone. Before you drop your work and rush their payment through, make sure they are telling the truth and the payment is actually past due. Once you get a phone call from such a vendor, add their name to the list of pushy vendors who will stretch the truth to lure an early payment from an unsuspecting accounts payable department Error Rates Not all payment errors are due to mistakes made by the paying company. Many invoices are not calculated correctly to start with. Whether the error is an intentional attempt on the part of the vendor to collect funds it is not owed or is an honest mistake is irrelevant to the paying company. Its accounts payable staff must deal with these errors. Ideally, the mistakes are found before the payment is made. In order to make the best decisions regarding potential changes, it is imperative that accounts payable associates have a good understanding of the basics of invoices. Summary Not all invoices are created equally. Proper handling involves following company policy and procedures as well as understanding what you are dealing with and what problems you may encounter with the invoices from various vendors.