Subsidiary Ledgers and Controls

Learning Outcomes

  • Describe the subsidiary ledger for Accounts Payable and its relationship to the General Ledger

In addition to the general ledger control account, the term accounts payable can also refer to the person or staff that processes vendor invoices and pays the company’s bills. That’s why a supplier who hasn’t received payment from a customer will phone and ask to speak with “accounts payable.” The accounts payable clerk would then look to the accounts payable subsidiary ledger which is a list of all outstanding bills listed by vendor (supplier, seller, service provider).

Accounting software allows companies to sort accounts payable according to the dates when payments will be due. The resulting report is known as an aging analysis, and is similar to the aging of accounts receivable, except in this case it is a list of bills due and management can use it to budget cash flow and auditors can use it to analyze the general ledger control account, looking for mistakes and even fraud.

Accounts Payable Process

A stack of papers.

The accounts payable process or function is immensely important since it involves nearly all of a company’s payments outside of payroll. The accounts payable process might be carried out by an accounts payable department in a large corporation, by a small staff in a medium-sized company, or by a bookkeeper or perhaps the owner in a small business.

Regardless of the company’s size, the mission of accounts payable is to pay only the company’s bills and invoices that are legitimate and accurate. This means that before a vendor’s invoice is entered into the accounting records and scheduled for payment, the invoice must reflect:

  • what the company had ordered
  • what the company has received
  • the proper unit costs, calculations, totals, terms, etc.

To safeguard a company’s cash and other assets, the accounts payable process should have internal controls. A few reasons for internal controls are to:

  • prevent paying a fraudulent invoice
  • prevent paying an inaccurate invoice
  • prevent paying a vendor invoice twice
  • be certain that all vendor invoices are accounted for

The accounts payable process involves reviewing an enormous amount of detail to ensure only legitimate and accurate amounts are entered in the accounting system. A well-designed system would include the following documents and procedures:

  • purchase orders issued by the company
  • receiving reports issued by the company
  • invoices from the company’s vendors
  • contracts and other agreements

Purchase order

A purchase order or PO is prepared by a company to communicate and document precisely what the company is ordering from a vendor. The people or departments receiving a copy of the PO include:

  • the person requesting that a PO be issued for the goods or services
  • the accounts payable department
  • the receiving department
  • the vendor
  • the person preparing the purchase order

The purchase order will indicate a PO number, date prepared, company name, vendor name, name and phone number of a contact person, a description of the items being purchased, the quantity, unit prices, shipping method, date needed, other pertinent information, and should be either prepared or approved by someone with authority to make purchases.

When the vendor receives a purchase order, it creates a sales order that goes to the shipping/fulfillment department. The vendor ships the items along with a packing list and sends an invoice such as the one we saw from Bryan Wholesale to Geyer.

Receiving Report

A forklift in a warehouse.

When the goods arrive, someone down on the shipping/receiving dock counts the items and prepares a receipt that then goes to the accounting department. There should be a system in place to be able to match that receiving report with the original purchase order. Items ordered but not yet received are on “back order”. So far, there hasn’t been a journal entry. The purchase order (and on the vendor side, the sales order) are memos only. The accounting system holds them, but there is no entry in the GL. If the terms are FOB shipping point, which is the most common, the vendor records a sale when the item is shipped and the invoice is prepared. Theoretically, the buyer would record the purchase at that point, but in practice, the purchase is usually recorded when the invoice arrives and is matched with the receiving report and the purchase order.

After determining that the information reconciles, the accounts payable clerk enters the vendor invoice into Accounts Payable. The information entered into the accounting software will include invoice reference information (vendor name or code, invoice number and date, etc.), the amount to be credited to Accounts Payable, the amount(s) and account(s) to be debited and the date that the payment is to be made. The payment date is based on the terms shown on the invoice and the company’s policy for making payments. Accounting software will automatically update both the subsidiary ledger and the general ledger.

Not all vendor invoices will have purchase orders or receiving reports. For example, a company does not issue a purchase order to its electric utility for a pre-established amount of electricity for the following month. The same is true for the telephone, natural gas, sewer and water, freight-in, and so on.

There are also payments required every month in order to fulfill lease agreements or other contracts. Examples include the monthly rent for a storage facility, office rent, automobile payments, equipment leases, maintenance agreements, etc. Even though these obligations will not have purchase orders, the process is essentially the same: enter them into the GL and the subsidiary ledger so that both are complete.

The accuracy and completeness of a company’s financial statements are dependent on the accounts payable process. A well-run accounts payable process will include:

  • the timely processing of accurate and legitimate vendor invoices,
  • accurate recording in the appropriate general ledger accounts,
  • the accrual of obligations and expenses that have not yet been completely processed,
  • segregation of duties, and
  • periodic review by either internal or external auditors.

End of the Period Cut-Off

A busy cafe counter.

At the end of every accounting period (year, quarter, month, 5-week period, etc.), it is important the accounts payable processing be up-to-date. If it is not up-to-date, the income statement for the accounting period will likely be omitting some expenses and the balance sheet at the end of the accounting period will be omitting some liabilities.

During the first few days after an accounting period ends, it is important for the accounts payable staff to closely examine the incoming vendor invoices. In the introduction, TheirCorp provided cleaning services for YourCo on December 15 and sent an invoice on January 15 dated January 10 for $600 with terms 2/10, net 30. Assume YourCo has a December 31 year-end and that $600 is considered a material amount. As the accounts payable clerk for YourCo, you know you must record an expense in December in the amount of $600, increasing accounts payable by the same amount. You may have to accrue that amount as a separate entry with a January 1 reversing entry, or you may have a system in place to back-date the invoice to December 15, but that may also affect the discount date which may adversely affect the payment. Mostly this is an issue that is only relevant at year-end. For instance, you may get an electricity bill on the 20th of the month that is for the 11th of the prior month through the 10th of the current month. Rather than prorating the amount and accruing it each month, it may be easier to simply enter it when received. This decision is based on a cost-benefit analysis that includes a materiality component: in other words, is the extra accuracy of the information worth the extra cost of making that calculation and entry every month. The answer may in fact be yes if, for instance, your company is a bauxite refinery using huge amounts of electricity each month that is directly related to production. It may be no if your company is an accounting firm or even a restaurant.