Title: What “On Account” Means — A Practical Guide for Businesses
Definition
– “On account” is an accounting phrase indicating a transaction made on credit or a partial payment applied against an outstanding balance. It commonly means the buyer receives goods or services now and agrees to pay later (purchase on account) or that a payment has been posted against a customer’s or vendor’s account without reference to a specific invoice (payment on account).
Key takeaways
– “On account” = purchase on credit or payment applied to an account rather than a single invoice.
– Purchases on account increase accounts payable; sales on account increase accounts receivable.
– Payments on account reduce the outstanding payable or receivable.
– Accurate recordkeeping and prompt matching of payments to invoices are essential for reliable financials and cash management.
How “On Account” works (conceptual)
– When a company buys goods on credit, it records the received goods or expense and creates (or increases) an accounts payable (AP) liability. The liability remains until the company pays cash or another settlement method.
– When a company sells on credit, it records revenue and creates (or increases) accounts receivable (AR). Collection reduces AR.
– A “payment on account” is a payment made toward a balance without specifying which invoice it is intended to settle. The payment is applied to the customer/vendor account and later matched to one or more invoices.
Typical journal entries
1) Purchase on account (inventory purchase example)
– Debit: Inventory (or Expense) $5,000
– Credit: Accounts Payable $5,000
2) Payment on account (paying supplier)
– Debit: Accounts Payable $5,000
– Credit: Cash/Bank $5,000
3) Partial payment on account (no invoice specified)
– Debit: Accounts Payable $10,000 (total balance)
– Credit: Cash/Bank $10,000
– Later reallocate the payment: apply $6,000 to Invoice A and $4,000 to Invoice B in the subledger or AR/AP records.
Numeric example
– A business purchases $5,000 of merchandise from Vendor X on account:
– Record: Debit Inventory $5,000; Credit Accounts Payable $5,000.
– Vendor sends statement showing $5,000 owed.
– The business later pays $3,000 (no invoice specified):
– Record: Debit Accounts Payable $3,000; Credit Cash $3,000.
– Remaining balance in AP for Vendor X = $2,000 until cleared.
Types / common uses of “On Account”
– Purchases on account (buyer’s AP): vendor credit terms, e.g., net 30.
– Sales on account (seller’s AR): invoice issued but not yet collected.
– Payment on account: payment against an open balance without invoice reference.
– Part-payment or deposit “on account”: partial settlement that reduces the outstanding balance.
– Clearing or allocation events: later matching payments to specific invoices.
Practical steps for recording and managing “on account” transactions
1. At purchase/sale
– Record the goods or services received/sold and create the corresponding AP/AR entry immediately.
– Capture vendor/customer details, invoice number (if available), date, terms, and due date.
2. When you receive or make a payment
– If payment references an invoice: apply the payment directly to that invoice in your accounting system.
– If payment is “on account” with no invoice reference: record the payment against the supplier/customer account and create a note to research and allocate later.
3. Reconcile regularly
– Reconcile vendor statements to your AP subledger monthly. Investigate unapplied or unallocated payments promptly.
– Maintain an AR aging and AP aging schedule to track overdue balances.
4. Apply internal controls
– Require remittance advice for incoming payments.
– Establish a policy for how unapplied payments will be handled (e.g., apply to oldest invoice unless payer specifies otherwise).
– Limit who can authorize allocations and refunds.
5. Use accounting software features
– Use subledgers to track individual invoice balances and unapplied payments.
– Use automatic matching rules where possible to allocate payments to open invoices.
– Maintain audit trails for when and how payments were applied.
Best practices
– Match payments to invoices as soon as possible to keep ledgers accurate.
– Keep a clear policy for applying payments made “on account” (e.g., FIFO, oldest invoice first, or per payer instructions).
– Reconcile vendor statements monthly to catch pricing, quantity, or timing discrepancies.
– Track unapplied cash in a suspense or unapplied payments account until allocation.
– Document communications with customers/vendors about allocations to avoid disputes.
Common pitfalls and how to avoid them
– Unapplied payments accumulate, causing AR/AP reconciliation problems — prevent by timely research and allocation.
– Misclassifying transactions (booking as expense instead of inventory, or failing to record payable) — ensure chart of accounts and procedures are clear.
– Ignoring remittance details from customers — require remittance advice and use electronic payment references.
– Losing track of partial payments — keep detailed subledger records and aging reports.
Industry variations
– B2B suppliers often have formal trade credit terms (e.g., net 30/60). Service industries sometimes bill after the fact; customers may make payments “on account” before an invoice is issued. Healthcare, legal, and construction may have retainers or progress payments posted “on account.”
Legal/contractual considerations
– Contract terms determine how payments on account are applied and when interest or late fees may apply.
– If a payment is made without specifying invoices, many jurisdictions or contracts allow the payee to apply it against invoices per agreed policy or law; check contract language or local regulations if disputes arise.
Month-end checklist (practical)
– Run AP and AR aging reports.
– Investigate and clear unapplied payments or suspense balances.
– Reconcile vendor statements to AP subledger; obtain explanations for discrepancies.
– Ensure all purchases on account during the period are recorded.
– Confirm payment terms are correctly reflected in the ledger for cash-flow forecasting.
Quick policy template suggestions
– Payment application: “All unapplied payments will be applied to the oldest outstanding invoice unless the payer specifies otherwise in writing.”
– Unapplied funds: “Funds held in an unapplied payments/suspense account must be investigated within five business days.”
– Approval: “Only AP staff with approval rights may reallocate or refund payments.”
When to consult an accountant or attorney
– If there are large discrepancies between vendor statements and your AP ledger.
– If customers dispute how a payment on account was applied.
– For complex contract terms surrounding partial payments, retainers, or cross-border transactions.
Source
– Investopedia — “On Account” (paraphrased and expanded) — https://www.investopedia.com/terms/o/on-account.asp
If you’d like, I can:
– Create sample journal entries tailored to your chart of accounts.
– Provide an AP/AR reconciliation template or a step-by-step allocation worksheet for unapplied payments.