Purchase of Inventory

Lets learn about accounting procedure of Purchase of Inventory. Companies basically made their purchase inventory on cash or credit. The companies usually record purchases when they receive the merchandise from the seller. Companies record cash purchases by an increase in Merchandise Inventory and a decrease in Cash. A purchase invoice should support each credit purchase. This purchase invoice specifies the total purchase price with all relevant information. The purchaser uses the copy of the sales invoice sent by the seller as a purchase invoice. To exemplify the purchase of inventory in details assume XYZ Company receives the goods on august 31. XYZ Company records this transaction of purchase on account at $900 as follows:

August 31

Inventory . . . . . . . . . … . . . . . . . 900
Accounts Payable . . . . . . . . . .        900
(To record purchased inventory on account.)

The purchase of inventory on account increases the account of assets (Inventory) and liabilities (Accounts Payable) XYZ Company, which is represented by the accounting equation:

Inventory               Accounts Payable$900           =        $900          +      $0

The Inventory account is generally applied only for goods purchased for resale. Supplies, equipment, and other assets are recorded in their own accounts. Inventory is considered as an asset until it is sold.

Purchase Discounts:

If there are some credit terms in case of credit purchase then these credit terms could allow the buyer to claim a cash discount for prompt payment. The buyer termed this cash discount as a purchase discount. This enticement offers advantages to both parties. For example the purchaser can saves money, and the seller can abbreviates the operating cycle by more quickly exchanging the accounts receivable into cash. The amount of the cash discount and time period in which it is offered are recognized by the credit terms. These terms also specify the time period that the purchaser is expected to pay the full invoice price. To illustrates the credit terms assume JVC’s credit terms of 5% 15, net 30 DAYS mean that XYZ Company may deduct 5% of the total debt if ABC Company pays within 15 days of the invoice date. Otherwise, the full amount— net —is due in 30 days. These credit terms can also be presented as 5/15 n/30. Terms of n/30 refers that no discount is provided and payment is payable 30 days after the invoice date. Terms of EOM mean that payment is payable at the end of the current month. XYZ Company paid within the discount period, so its cash payment entry is

September 8

Accounts Payable . . . . . . . . . . 900
Cash ($900 × 0.95) . . . . . . . . . . . 855
Inventory ($700 × 0.03) . . . . . . . . .  45
(To record paid within discount period.)

The purchase discount is credited to the Inventory account. As the discount decreases XYZ company cost of goods, which is shown in the Inventory account:


August30           900 September8     45
BAL.                   855

XYZ Company must have to pay the full amount of $900; If XYZ Company pays this invoice after the discount period. And then payment entry will be as follows:

September 21

Accounts Payable. . . . 900
Cash . . . . . . . . . . . . .            900
(To record paid after discount period.)


august  31 900

But if the seller does not chosen by buyer to provide a cash discount for prompt payment, then credit terms will state only the maximum time period for paying the balance due. For example, the invoice may require that the time period as n/30, n/60, or n/15 EOM. This means, respectively, that the buyer must pay the net amount in 30 days, 60 days, or within the first 15 days of the next month. When the buyer pays an invoice within the discount period, the amount of the discount decreases Merchandise Inventory as the companies’ record inventory at cost price and, by paying within the discount period; the merchandiser has condensed that cost.

Purchase Returns & Allowances: Customers sometimes become dissatisfied with some products that are defective, damaged, or otherwise incompatible. In these situations the purchaser or the buyer return these defective goods to the seller for credit if the sale was made on credit, and for a cash refund if the purchase was made on cash. This process of transaction is referred as a purchase return. On the other hand, the purchaser may will to keep the merchandise if the seller is willing to approve an allowance (deduction) from the purchase price. This transaction is known as a purchase allowance. The seller subtract an allowance from the amount that buyer owes. Both purchase returns and purchase allowances decrease the buyer’s cost of the inventory. For example XYZ Company has bought a product at $400 which is damaged in shipment. Thus the buyer returns the product to the seller and records the purchase return as follows:

September 2
Accounts Payable . . . . . . . . $ 400
Inventory . . . . . .  . . . . .                    $ 400

(To record returned inventory to seller.)

A purchase return decreases the accounts of assets and liabilities of XYZ Company as shown by the accounting equation:

Inventory               Accounts Payable
$400           =        $400          +      $0