How to Record Payments in Accounting

What Is a Payment in Accounting?

In accounting, recording payments and keeping track of it is an essential task. After all, payment is one of the trivial components of an economic transaction from which a business sustains and stabilizes its business venture. 

Every individual, let alone a business, indulges in purchases one way or another. It is how we acquire commodities for our needs and wants by compensating the seller. Similarly, a business acquires commodities to sustain its business operations. 

The event of purchase has two natures: cash purchases and credit purchases. Cash purchases are payments made at the time of the event of the transaction. However, credit purchases are payments made at the mutually agreed due date, incurring liability for the company. 

Typically, a business is involved in both cash and credit purchases, more so with the credit than cash due to its perks after considering drawbacks. Regardless of whether the purchase is credit or cash, the transaction still needs to be accounted for. 

Recording both credit and cash payments is essential, especially when it directly affects the company's financial statements. Based on this, many external users, such as banks and suppliers, decide whether to invest their time and resources in lending their services.

Why Should We Record Payments? 

If you are a working professional accountant, you know firsthand how important it is to ensure a proper accounting control system is in place. From recording to perseverance from potential fraud, the accounting department is the bridge for smooth reporting and tax filing.

Due to the severity that accounting poses to the business and its effect on its users, external auditors specifically scrutinize the accounting procedures and controls of the company’s accounting department. You don’t want tax authorities to be behind you, right? 

There is a reason why the accounting industry is heavily regulated around the world, and there exists an accounting standards body regulating accounting standards to maintain quality, credibility, and consistency across companies in the post-globalization era. 

As mentioned before, payments are one of the most sensitive components of accounting. It is easily prone to fraudulent activities within the company. 

It can be a rollercoaster; mind you, it is not as simple as “payments,” as we call it; there is more to it. Those who have worked with the payments know well that each payment transaction is different due to its circumstances, clauses, properties, identifiers, and whatnot.

Being a professional, you either work directly with the clients, or you might be working in an organization whose payments you have to record. It can be a daunting task for those who are especially beginners, but fear not; this article should simplify in general.  

Types Of Payment

From a broad perspective, a company can indulge in two types of payments depending upon the situation with the payee. This categorization allows companies to explore available payment options appropriate to the circumstances. They are:

1. Asset-Based Payments: This type of payment allows the payer to compensate the payee using the resources of monetary value for the obtained goods and services. The common sight would be cash and stocks or even any tangible assets of similar exchange value (we are going back to the barter system). 
2. Liability-Based Payments: This type of payment allows the payer to incur a liability to which the payer will pay to the payee in the future. The common sight would be credit-based transactions and employee month-end salaries. 

Why don't we explore some more forms of payment a business would likely indulge in during its operations? After all, we are talking about payments. 

Below, we shall explore some of the most common forms of payment that a business or individual normally encounters.

The Payment Recording Processes

Payments, at first glance, may not look like a deal breaker, especially when there are profits, sales, etc. But practicality says otherwise, as payments are one of the sensitive controls for a company, sensitive enough to manipulate the records. 

It’s no wonder why there is a separate accounts department dealing with payments (Cost accounting), as inefficient payment management can drive the company to depths of debt when a company can leverage it for efficiency. 

Typically, there are several phases when it comes to the payment recording process. They are as follows:

1. Determine the due beneficiary

The first and foremost step is to determine who is the beneficiary by obtaining all the legal information about the payee. Information such as individual or company’s name, address, contact details, date of transaction, bank details, preferred form of payment, etc. This helps to confirm the obligation and take appropriate steps. 

2. Verify and validate the payment details

Upon determining the appropriate payee, verify the transaction with internal records of the transaction that occurred, such as invoices. This evidence proves the occurrence and, therefore, reduces the chances of unwanted cash outflow, reducing the chances of fraud. 

3. Consider the exchange rates (if applicable)

If the transaction took place via foreign trade, i.e., the seller is in a different country, consider the current foreign exchange rates as they can either make you pay less than what you are required to or make you pay more than what you owed.

4. Payment execution

At this point, the company should come to the final conclusion regarding the financial obligation along with the evidence of the obligation.

There is no point in holding the due amount unless it is for a strategic purpose like holding cash reserve longer to sustain the business operation (but be aware this can backfire by tampering with the relationship if done above the limit); it is time to make the due payment. 

5. External compliance screening 

This is the stage where the payment (if done via a bank or a third party provider) would further screen the transaction, ensuring the payment is sent from a legitimate source to a legitimate destination (payee’s account) before the payment is processed. This may take a few minutes to a few days, depending on the transaction itself. 

6. Document the payment

After the due payment has been paid to the rightful entity, it is of utmost importance for the company to record the paid due amount (even if the payment is still being processed by the bank or third-party provider).

7. Reconcile the accounts 

Recording the monetary movements is crucial to businesses; it is also of utmost importance to maintain the accuracy and consistency of such accounts. Reconciliation does just that. Every accounting department should indulge in reconciliation and internal audits every year. 

The recommended best practice is to reconcile accounts at the end of every month. Thus ensuring accuracy and consistency across the books of accounts and controls, allowing smooth external audits, tax filings, financial statement preparations, and other external requirements.

How To Record A Payment?

Posting a recording entry shouldn't be a hassle. Understanding how to construct an entry is just like constructing a sentence in a language. Just structure the logic by assessing the event that has occurred. As simple as that! 

It should be easier to construct after we have understood the component in place, i.e., Accounts Payable.

Example:

“Techno trading company engages in selling electronic gadgets as a retailer. On 23rd October 2023, Techno Trading purchased inventories for resale purposes worth $88,000 on credit from a popular Japanese wholesaler, YZ Tenkai, who is based in Japan.

Techno Trading received a credit period of 60 days but decided to pay within the due period because of the early 10% purchase discount YZ Tenkai offers for early payments. Techno Trading makes the payment on 22nd November 2023 (30 days before the due date)”. 

Implement Modern Accounting Rule 

Following an accounting rule makes it so much easier to construct a journal entry. Just assess the situation at hand, identify the variables and the position of their value, and finally construct an entry based on the rule. It will sound just like an actual sentence! 

Now, there are two accounting rules, one being the Golden Rule (which is outdated) and the second being the Modern Rule, which is an updated version. Since we like it easy to understand and implement, we will go for the Modern Rule. 

Is Payment a Debit or a Credit?

This question arises for any professional when they actually start working in the accounts department and deal with the processing of recording accounts payable themselves.

When a payment is made, it typically involves a decrease in cash or a decrease in a bank account balance. In double-entry accounting, every transaction has two sides: a debit and a credit.

• If cash is being paid out, the cash account is credited (decreased) because cash is an asset, and assets decrease with credits.
• The other account involved will be credited or debited depending on the nature of the payment. 

For example, if you're paying for an expense, the expense account would be debited (increased) because expenses increase with debits.

So, whether a payment is recorded as a debit or a credit depends on the accounts involved and the specific transaction being recorded.

Example of Recording Payments in Accounting

Now, getting around the basics has led to this moment. Let's find the solution for the above-mentioned illustration. We will break down the process and explain how the payment is recorded in accounting. 

Step 1: Determine the due beneficiary 

The first step for Techno Trading is to know to whom it should pay. Using the internal records about the wholesaler company and how much amount is due, Techno Trading has identified the due obligation towards YZ Tenkai for the credit transaction it has to fulfill.

Step 2: Verify and validate the payment details

Since the due beneficiary is identified, it is in the best interests of the paying party to ensure the “due” amount is factually obligated in nature. 

It doesn’t require sophisticated measures; just gather the recorded accounts, such as Accounts Payable, along with any physical evidence of the transaction, such as invoices, purchase orders, etc. This should solidify the obligation and reduce the chances of cash loss or fraud. 

The accounting department validates the transaction based on the evidence of occurrence. And since the purchase transaction of Techno Trading has occurred on a credit basis, the credit purchase transaction would be recorded into Techno Trading’s ZohoBooks as 

Step 3: Consider the exchange rates (if applicable) 

Since Techno Trading engaged in foreign trade with a Japanese wholesaler, YZ Tenkai, Techno Trading should consider the implications of the current exchange rate posed to Techno Trading as the exchange rate will either make Techno Trading pay more or pay less. 

The foreign exchange rate as of 23rd October 2023 for 1 US Dollars weighed 149.70 JPY. This is when the credit purchase took place. On the payment date, i.e., 22nd November 2023 (30 days later), the foreign exchange rate is 1 USD weighing 149.53 JPY.

We observe that there has been a decrease in the currency exchange rate, a 0.11% drop since 23rd October 2023, to be specific. Well, it is good news for Techno Trading as the company has to pay 0.11% less, to put in numbers, $87,920.80 to YZ Tenkai.

Step 4: Payment

After confirming the due obligation, reviewing the transaction specifics, and factoring in the prevailing exchange rate, there appears to be no compelling reason to delay the payment (aside from standard cash management practices). 

In fact, there's a clear advantage to making the payment promptly, as YZ Tenkai has extended a 10% trade discount for early settlement.

Step 5: External compliance screening 

Initial screening of the due transaction is done at the second stage of this process by Techno Trading. 

Step 6: Document the payment

The accounting team should account for the payment as well as any adjustments that occurred since the time of the last recording of an exchange. Any additional fees, charges, cost cuts, or anything that influences the book value of the transaction should be accounted for. 

Here, Techno Trading has paid 30 days before the due date (22nd November 2023) and received a 10% discount. This discount needs to be accounted for. The transaction for the payment and the discount allowed would be recorded in Techno Trading’s ZohoBooks as

Step 7: Reconcile the accounts

Techno Trading indulges in reconciliation efforts at the end of every month. It ensures accuracy and consistency in its accounting system and controls, leading to more confidence when presenting such accounts to those who use them. 

Since reconciling efforts are carried out at the month's end, it accounts for any delayed records of the third-party provider, such as banks, as they may reflect the transaction late in their statement due to the transaction processing period. 

In the internal books of account of Techno Trading, the payment of the occurred credit purchase should be recorded in this manner. 

When the accounting team takes on the bank reconciliation by comparing the company’s bank account statement with the internal statement, the accounting team should notice that Techno Trading’s bank account statement reflected as 

Techno Trading 

Bank Statement 

Researched and authored by Muhammed Ishfaque Ishaque | LinkedIn 

Reviewed and edited by Parul Gupta | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Accountant
• Book Value
• Contra Asset
• Hobby Loss
• Inventory