Purchase is the cost of buying inventory during a period for the purpose of sale in the ordinary course of the business. It is therefore a kind of expense and is hence included in the income statement within the cost of goods sold. Purchases may include buying of raw materials in the case of a manufacturing concern or finished goods in the case of a retail business.
However, in accounting, we have to differentiate between purchases as explained above and other purchases such as those involving the procurement of a fixed assets (e.g. factory machine or building). Such purchases are capitalized in the statement of financial position of the entity (i.e. recognized as assets of the entity) rather than being expensed in the income statement.
Accounting for Purchases
As purchase results in increase in the expense and decrease in assets of the entity, 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 as will be further discussed in the inventory accounting section.
A purchase may be made on Cash or on Credit.
Cash Purchase
When a cash purchase is made, the following double entry is recorded:
|
Debit |
Purchases (Income Statement) |
|
Credit |
Cash |
Purchase is debited to account for the increase in expense.
Cash is credited to account for the decrease in cash of the entity.
Credit Purchase
In case of a credit purchase, the following double entry is recorded:
|
Debit |
Purchases (Income Statement) |
|
Credit |
Payable |
The double entry is 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. The following double entry is recorded:
|
Debit |
Payable |
|
Credit |
Cash |
Recognition of Purchases
It may be confusing to identify the point when a purchase occurs. Do we recognize purchase when the goods are dispatched by the supplier, when we receive the goods, or when we pay supplier in respect of those goods? In case of purchase of goods, purchase is generally said to occur when the seller transfers the risks and rewards pertaining to the asset sold to the buyer. This generally happens when buyer has received the asset. The payment to supplier is not relevant to when purchase is recognized since expenses are recorded under the accruals basis.