Accounts payable form the largest portion of the current liability section on the company’s financial statements. It represents the purchases that are unpaid by the enterprise.
In the cash conversion cycle, companies match the payment dates with accounts receivables making sure that receipts are made before making the payments to the suppliers. Lower the accounts payable days the better. It reflects that the company is able to realize the cash in good fashion.
Process flow of accounts payable
The following is the paper trail in the cycle of accounts payable:
- The buyer asks for a quotation from suppliers along with payment terms and conditions.
- The buyer makes the purchases from suppliers on the account.
- The buyer receives the inventory/purchases.
- The buyer checks the purchases made for the quality he ordered and decides whether to accept the order in partial and full.
- The buyer makes purchases return for purchases which are found to be defective.
- The buyer makes the payment in full.
- Any outstanding liability is carried forward to next year.
5 Reasons why accounts payable are overstating:
Accounts payable overstatement causes inaccurate reporting of financial statements resulting in inaccurate income statement profit and loss and balance sheet as a whole.
There are various data errors that render accounts payable to overstated. These can be corrected by determining the cause of overstatement.
1) Inventory variances – overstating inventory
Incorrect inventory input and cost of goods sold is likely source of overstatements of accounts payable. When purchases are made on credit, accounts payable are created.
When the inventory balances are overstated, this shall too reflect on the account’s payable balances. Further, discrepancies may occur when the company records all inventory transactions without correctly following inventory valuations.
2) Incorrect transaction dates
Let’s take an example that purchases were made on account as on the 1st of December,2019 and received on 12th Jan, next year. The accountant shall correctly record the purchases on 1st Dec, 2019.
However, due to confusion surrounding the dates, he records on 12th Jan 2020. This will overstate the accounts payable balance for the year 2020. This will overstate the accounts payable balance for Jan month and understate the balance for the December month.
3) Incorrect invoices
Let’s take an example. Mr. James made purchases of $ 50,000 from Mr. Daniel. The inventory was received as usual and accounted for. Mr. Daniel erroneously sent the invoices for $ 55,000.
In the books of Mr. James, the accountant made error of recording the invoice and overstated the accounts payable balance by more than $ 5,000.
This may have verified through robust internal control but the accountant did not do so and resulted in discrepancy in record in the books of Mr. James. Such discrepancy can only be removed and corrected through cross-checking of accounts and balances.
4) Wrong opening balances
Imagine the accountant has already overstated the accounts payable balances last accounting period. This will be also reflected in the current accounting period unless rectified.
5) Incorrect entry posting
There are always errors of commission and omission relating to the recording of financial transactions. The accountant can omit to record the posting of purchases accounts in the accounts payable account.
Although this will be correctly reflected in inventory outstanding, the accounts payable will be more than the outstanding actual balance.