Meaning Of Purchases In Accounting

Meaning Of Purchases In Accounting

Meaning Of Purchases In Accounting
A market
Purchase is the cost of buying inventory or goods during a period with the aim of resale in the ordinary course of the business. Hence, Purchases is a kind of expense and it is therefore included in the income statement within the cost of goods sold. In manufacturing concern, Purchases may include buying of raw materials. While for retail business, purchase means buying of finished goods.

However, it is very important to know that in accounting, we have to differentiate between the purchases that was explained above and other purchases such as those involving the procurement of a fixed assets (e.g. factory, plant and machinery, motor van, land and building, etc). The purchases involved in procurement of fixed assets are capitalized in the statement of financial position of the business (i.e. they are recognized as assets of the business) rather than being expensed in the income statement. The income statement is also called Trading, profit and loss account.

ACCOUNTING FOR PURCHASES
As purchase leads to an increase in the expense of the business and decrease in assets of the business. Therefore, expense must be debited while assets must be credited. A purchase also results in increase in inventory, however the accounting for inventory is kept separate from accounting for purchase.

In Business, purchase may be made on Cash or on Credit.

CASH PURCHASE
Cash purchase occurs when a trader buys goods and pay immediately. When a cash purchase is made, the following double entry is recorded:
  1. Debit Purchases (Income Statement)
  2. Credit cash
Purchase is debited to account for the increase in expense. Cash is credited because there is a decrease in cash (asset) after payment of the goods.
CREDIT PURCHASE
Credit purchase occurs when there is an exchange in goods between the buyer and the seller but payment will be in future. In the case of a credit purchase, the following double entry is recorded:
  1. Debit Purchases (Income Statement)
  2. Credit Payable (Creditor)
When you purchase goods on credit, you will have an increase in Creditor. Creditor means the people you are owing.

The double entry is the same as in the case of a cash purchase, except that the credit entry is made in the payable ledger rather than the cash ledger.

When the payable is paid his due, the payable balance will be reduced to nil (depending on whether he has old debts or not). The following double entry is recorded:
  1. Debit Payable (Reduction in liabilities)
  2. Credit Cash (Reduction in assets)

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