Purchase Order Clearing (#262)
/In this podcast episode, we discuss purchase order clearing. Key points made are noted below.
Overview of Purchase Order Clearing
Purchase order clearing is based on a standard report that’s located in the purchasing module of your accounting software. It lists all purchase orders for which there’s either no associated receipt or no associated supplier invoice – or both. For each of these open purchase orders, the report states everything you need to track down what’s going on, such as the purchase order number, the number of units originally stated on the order, the number of units received, and the number of units billed to the company.
Examples of Purchase Order Clearing
For example, let’s say that the report indicates an original order quantity of 1,000 units, and that zero units were received or invoiced to the company, and that the purchase order was issued several months ago. A reasonable assumption is that the purchase order was not actually issued, or the supplier rejected or lost it. In this case, the likely follow-up action is to check with the purchasing department to see if they plan to formally cancel the purchase order, which will remove it from the report.
Now let’s change the facts, so that the report indicates that 950 units were received and invoiced to the company. This is pretty common. The supplier shipped a bit less than the full amount, and will either ship the remainder later, or the purchasing department should get around to formally cancelling the remaining amount. No issues for the accountant here.
The remaining two variations are more interesting. Let’s assume the same 950 units were received, but the report indicates that the supplier never issued an invoice – or at least, it was never logged into your accounting system. In this case there’s a problem, because the inventory has been logged into the system as an inventory asset, with an offsetting credit going to the purchases clearing account, which is a liability account. The amount in the clearing account will stay there until you can log in the supplier’s invoice, which hasn’t arrived. So, you need to contact the supplier, figure out what happened to the invoice, and get a copy of it. When you enter the supplier’s missing invoice into the payables module, it references the purchase order number, which notifies the system to move the credit in the purchases clearing account over to the payables account.
Purchase Order Clearing in Accounting
In short, the purchases clearing account is a short-term parking spot for received goods, which indicates that a supplier invoice should be on its way soon. As the accountant, you should be scanning through the purchases clearing report for any cases in which goods have been received, but no invoice, and tracking down the invoices. To save work, you can certainly wait until a week has passed since the receipt of goods, since some suppliers take a while to issue invoices. After that, assume that there’s a problem.
And then we have the other variation, where the clearing report shows that a supplier invoice was received, but the goods were not. In this case, either the supplier has somehow mistakenly issued the invoice but not the goods, or the goods were shipped somewhere else, or your receiving department didn’t log in the receipt. You can address all of these options by asking the supplier for a proof of delivery document, such as a FedEx or UPS signature from the recipient. If there’s no proof of delivery, then the supplier probably screwed up and never sent the goods. That is not likely.
It’s much more likely that the goods were delivered, in which case you have to find them and then persuade the receiving staff to log the receipt into the system. By doing that, the receipt is matched with the supplier invoice and the whole thing is flushed out of the purchases clearing account.
So why do we use the purchase order clearing process? First, it ensures that the book balance for inventory items is as accurate as possible. Second, it ensures that supplier invoices are always posted to the system, so that payments to suppliers go out on time. This tends to improve supplier relations, and also gives you more time to take advantage of early payment discounts. And finally, this clearing process improves the accuracy of both the ending inventory and accounts payable balances, which is useful for closing the books and producing accurate financial statements.
Frequency of Review
How frequently should you review the clearing report and the clearing account? It depends. If your company issues a lot of purchase orders and the process is a bit buggy, then you might have to do it every day. In the reverse situation, once or twice a month might be enough. In the latter case, I suggest doing a review a few days prior to the end of the month. That’s because it may take a few days to investigate what’s wrong and then correct the inventory and payables records in time for month-end. A good way to see if there’s something wrong is to plot the total dollar amount in the purchases clearing account on a trend line. If the balance in the account is perpetually going up, then you probably have a lot of issues clogging up the account.
Trend Line Analysis
But. There’re two cases in which an increasing trend line does not necessarily indicate a problem. One is when the company is growing rapidly. In that case, you can expect the clearing account to grow at about the same rate as the growth rate for sales – or, more accurately, the growth rate for purchases. And the second case where the trend line can be justifiably going up is when the purchasing department decides to use purchase orders to buy a larger proportion of the goods being purchased. In that case, the clearing account will probably increase in size.
Reconciliation Difficulty
One final note is that the clearing report is simply a status report. The information in the report should represent the detail in the clearing account. However, the report may not even have a grand total stated anywhere on it, so you can’t necessarily reconcile the report to the clearing account.