Purchase Order

A purchase order (PO) is a formal document issued by a buyer to a supplier that authorizes the purchase of goods or services. It specifies what is being bought, in what quantity, at what price, when and where it should be delivered, and on what payment terms. When the supplier accepts the order, in writing or by shipping the goods, the purchase order becomes a legally binding contract. In the United States, contracts for the sale of goods, including those formed by purchase orders, are governed by Article 2 of the Uniform Commercial Code (UCC).

Purchase orders are central to a company's purchasing, or procure-to-pay, process. They give the buyer a record of what it has committed to spend, they give the supplier clear instructions, and they provide accounting with the information needed to approve the supplier's invoice for payment.

• A unique PO number, the order date and the buyer's and supplier's details.
• A description of each item, with part numbers, quantities, unit prices and totals.
• Delivery date, shipping address and shipping terms, such as FOB shipping point or FOB destination, which determine when ownership and risk pass.
• Payment terms, such as net 30 or 2/10, net 30, in line with agreed supplier payment terms.
• Authorization by someone with the authority to approve spending of that amount.

A typical sequence is: an employee raises a purchase requisition; the purchasing department approves it and issues a purchase order; the supplier delivers the goods; the receiving team records what arrived on a receiving report; and the supplier sends an invoice. Before payment, accounts payable performs a three-way match, comparing the purchase order, the receiving report and the invoice. If quantities and prices agree within set tolerances, the invoice is approved and recorded in accounts payable.

No journal entry is made when a purchase order is issued, because nothing has yet been received and no liability exists. The liability arises when goods are received or title passes. Open purchase orders, however, represent commitments, and significant unconditional purchase obligations must be disclosed in the notes to the financial statements as commitments.

A bakery issues PO 4512 for 500 bags of flour at $12 each, a total of $6,000. The delivery arrives with 480 bags, which the receiving clerk records. The supplier's invoice bills for 500 bags at $12.50, or $6,250. The match shows two differences: 20 bags were not delivered, and the price is higher than agreed. The expected invoice amount is:

Here $\text{Quantity received}$ is taken from the receiving report and $\text{PO unit price}$ from the purchase order. The approved amount is 480 times $12, or $5,760. Accounts payable records a liability of $5,760, debiting inventory, and asks the supplier for a corrected invoice. The $490 difference is not paid unless the purchasing department agrees to the price increase and the missing bags are delivered.

Purchase orders support internal control by ensuring that only authorized purchases are made, at agreed prices, and that the company pays only for what it receives. They help prevent duplicate payments, fictitious suppliers and unauthorized spending, and they assist budgeting by showing committed spending before invoices arrive. Separating the people who approve purchase orders, receive goods and approve payments is a basic segregation of duties. Many businesses use procurement software that creates electronic POs, routes them for approval and performs matching automatically, and screen suppliers through vendor risk management. For low-value, recurring purchases, companies often use blanket purchase orders or purchasing cards instead of individual POs. Suppliers that need cash to fulfill large orders can sometimes borrow against them through purchase order financing.