Inventory Purchase Journal Entry
Overview
Inventory is usually a big asset for the company, especially the merchandising company, as buying and selling the inventory is usually its main activity in the operation. Hence, it is important to properly account for inventory purchases in making journal entries into the accounting record. A mistake of recognition of inventory purchase may lead to a big misstatement on both the balance sheet and income statement.
There are two methods or systems to account for inventory including the perpetual system and periodic system. Likewise, the company uses one of the two systems to make journal entry for inventory purchase.
In the journal entry of inventory purchase, the difference between the perpetual system and periodic system is on the debit side. Under the perpetual system, the amount of inventory purchase is posted to the inventory account while, under the periodic system, it is posted to the purchase account instead.
Inventory purchase journal entry
Perpetual inventory system
Under the perpetual system, the company can make the inventory purchase journal entry by debiting inventory account and crediting accounts payable or cash account.
| Account | Debit | Credit |
|---|---|---|
| Inventory | 000 | |
| Accounts payable/cash | 000 |
In this journal entry, there is no purchase account and the amount of purchase directly goes to the inventory account by adding to the inventory balances. This way the company can view the inventory balances after posting the purchase journal entry (or at any time). This is one of the big advantages of the perpetual inventory system.
Also, the purchase transaction does not involve income statement items. Although there is an increase in accounts payable or cash out here, the cost has not occurred yet. The cost usually only occurs when the company makes the sales of inventory.
Periodic inventory system
Under the periodic system, the company can make the journal entry of inventory purchase by debiting the purchase account and crediting accounts payable or cash account.
| Account | Debit | Credit |
|---|---|---|
| Purchase | 000 | |
| Accounts payable/cash | 000 |
The purchase account is a temporary account, in which its normal balance is on the debit side. It will be used for the calculation of cost of goods at the end of the period. And after closing entries, the purchase account will have zero balance.
Likewise, there is no inventory account involved when the company purchases the inventory in. The inventory account only appears when the company closes the entries, (e.g. the beginning inventory is credited to close old balances and the new inventory after the physical count is debited to record the ending inventory).
Example
For example, on October 12, 2020, the company ABC Ltd. receives the inventory it purchases on credit from one of its suppliers. The inventory purchases amount to $5,000 and the company ABC Ltd. uses the perpetual inventory system. What is the journal entry for the purchase transaction?
If the company ABC Ltd. uses the periodic inventory system instead, what is the journal entry for the inventory purchase?
Solution:
Perpetual inventory system
Under the perpetual system, ABC Ltd. can make the journal entry for inventory purchase on October 12, 2020, as below:
| Account | Debit | Credit |
|---|---|---|
| Inventory | 5,000 | |
| Accounts payable | 5,000 |
In this case, the $5,000 will directly add to the balances in the inventory account. Likewise, on October 12, 2020, the company can check how much balances the inventory has after adding $5,000 of purchase.
The company can also review and verify the inventory on October 12, 2020, by comparing the inventory in the account record with the physical inventory count. This is a big advantage of the perpetual inventory system as the company can investigate immediately if there is any variance between the physical count and the account record.
Periodic inventory system
If ABC Ltd. uses the periodic inventory system instead, it could make the journal entry for inventory purchase on October 12, 2020, as below:
| Account | Debit | Credit |
|---|---|---|
| Purchase | 5,000 | |
| Accounts payable | 5,000 |
In this journal entry, the purchase of $5,000 does not add to the inventory balance but it will be used in the cost of goods sold calculation. The inventory balances will be based only on the physical count of inventory at the end of the period. Hence, unlike in the perpetual system, the company cannot check how much balances the inventory has immediately after adding the $5,000 of purchase on October 12, 2020.
It is useful to note that the purchase account is for inventory only. So, any purchase of equipment or office supplies should never be posted into the purchase account. Otherwise, there will be a misstatement in the calculation of the cost of goods sold at the end of the period.