What Is a Purchase Order in Accounting?
Learn the essential role of purchase orders in accounting for formalizing transactions, managing spend, and ensuring financial accuracy.
A purchase order (PO) is a formal document issued by a buyer to a seller, outlining the types, quantities, and agreed-upon prices for products or services. It plays a fundamental role in accounting and financial management by creating a clear record of purchase intentions, managing procurement and ensuring transparency in transactions.
Understanding What a Purchase Order Is
A purchase order becomes a legally binding document once accepted by the seller, formalizing a buyer’s intent to purchase specific goods or services. It serves as an official offer to buy.
Key information found on a purchase order includes a unique PO number, the date of issue, and details for both the vendor and the buyer. The PO also specifies a description of the items or services being purchased, including quantity, unit price, and the total cost.
Purchase orders also include logistical information like delivery instructions, expected delivery dates, and payment terms. They communicate buyer requirements to the seller and establish a documented agreement, minimizing misunderstandings.
The Purchase Order Process in Accounting
The purchase order process begins with a requisition, an internal request from a department for goods or services. The requisition details items, quantities, and reasons, requiring internal approval.
Once the requisition receives approvals, the purchasing department creates the formal purchase order. It incorporates approved details and is sent to the vendor, signaling commitment to the stated terms.
Upon delivery, the receiving department verifies the shipment and generates a receiving report. This report confirms items received and their condition.
Subsequently, the vendor sends an invoice for the delivered goods or services, detailing the amount owed and referencing the PO number. This initiates payment authorization.
The “three-way match” compares the purchase order, receiving report, and vendor’s invoice. All three must align on items, quantities, and prices before payment. This verification prevents unauthorized payments and ensures payment only for what was ordered and received.
Advantages of Using Purchase Orders
Purchase orders offer several benefits, including enhanced cost control and budgeting. They provide visibility into committed expenditures, allowing companies to track spending against budgets and prevent overspending. POs also play a significant role in fraud prevention.
POs improve accuracy by minimizing errors. Detailed documentation reduces misunderstandings, incorrect shipments, and billing disputes.
POs create a clear audit trail. This record is valuable for audits, provides evidence of financial activities, supports compliance, and facilitates dispute resolution.
A PO offers legal protection for both parties. This contractual basis provides recourse in case of non-compliance with agreed-upon terms, safeguarding the buyer’s interests.
For physical goods, POs aid inventory management. They help anticipate incoming stock, optimize storage, and prevent stockouts or excessive inventory.