What Is a Purchase Order in Accounting?

A purchase order (PO) is a foundational document for acquiring goods or services for a business. It formalizes a buyer’s intent to purchase, outlining specific transaction details. Understanding POs provides clarity for buyers and sellers. This document helps streamline procurement activities, ensuring efficient purchase management. This article explores POs, including their definition, accounting significance, workflow, and essential details.

Defining a Purchase Order

A purchase order (PO) is a commercial document from a buyer to a seller, detailing types, quantities, and agreed prices for products or services. It acts as a formal offer, detailing transaction terms. Once accepted by the seller, the PO becomes a legally binding contract between the two parties. Its primary purpose is to formalize an order and record the buyer’s commitment.

It specifies items, quantity, price, and other terms, reducing misunderstandings. Unlike an invoice (a seller’s request for payment after delivery), a PO is a buyer’s document to place an order.

Accounting Significance of Purchase Orders

Purchase orders provide financial control and transparency within an organization. They prevent unauthorized spending by requiring documented approval. POs mitigate fraud and errors by recording authorized purchases. This trail ensures expenditures align with budgets and policies.

Organizations use POs for budgeting and expense tracking. Each PO commits funds, allowing finance teams to forecast cash outflows and monitor spending against budgets. This approach helps businesses maintain financial discipline and avoid overspending.

POs provide an audit trail for internal and external audits. Auditors can trace purchases from request to payment, ensuring compliance. This documentation supports accurate financial reporting, as committed expenses impact financial statements. Open POs can represent future liabilities, influencing accounts payable and potentially impacting the cost of goods sold once items are received.

The Purchase Order Workflow

The typical lifecycle of a purchase order begins with an identified need for goods or services within a department. An employee or department creates a purchase requisition, formally requesting the acquisition. This requisition undergoes internal approval, often involving managers and finance personnel, to ensure the purchase is justified and within budget. Once approved, the purchasing department generates and sends the PO to the vendor.

The vendor reviews and accepts the PO, making it a legally binding contract. After acceptance, the vendor ships goods or provides services. Upon receipt, the receiving department documents delivery, often creating a receiving report.

The “three-way match” compares the purchase order, receiving report, and vendor’s invoice. This process verifies ordered items were received and the invoice reflects the agreed price and quantity. If documents reconcile, accounts payable processes payment. This matching prevents incorrect or duplicate payments and ensures financial accuracy.

Key Purchase Order Details

A standard purchase order document includes specific information for clarity and accuracy. Each PO has a unique number for tracking and referencing. The issue date establishes a transaction timeline. Buyer and vendor details are included, such as company names, addresses, and contact information.

The PO’s core is a detailed description of items or services. This includes quantity, unit price, and total price for each line item, often with a grand total. Additional information includes delivery instructions, such as shipping address and desired delivery date. Payment terms (e.g., net 30 days) are specified. Finally, the document includes fields for authorization signatures, confirming internal approval.