Journal entry for purchasing goods on credit
Introduction
In accounting, when we purchase the goods on credit, there will be a liability that exists at the time of purchase. In this case, we need to make the journal entry for purchasing goods on credit in order to account for the liability that occurs as a result.
Likewise, the total liabilities on the balance sheet will increase as a result of purchasing goods on credit. On the other hand, if we purchase the goods in cash, there won’t be any liability occurring as a result of the purchase. However, there will be an immediate cash outflow from the business.
In business, the liability that occurs from the credit purchase of goods usually represents that we have a good relationship with our supplier. After all, purchasing goods on credit means that we can avoid the immediate cash outflow from the business. And the cash outflow only occurs at a later date, in which the supplier will have to bear the credit risk of us not being able to pay back if we face a major financial crisis afterward.
Journal entry for purchasing goods on credit
We can make the journal entry for purchasing goods on credit by debiting the purchases account and crediting the accounts payable in the periodic inventory system.
| Account | Debit | Credit |
|---|---|---|
| Purchases | 000 | |
| Accounts payable | 000 |
The purchases account in this journal entry is a temporary account that will be cleared at the end of the accounting period when we prepare the income statement for the period. And the total amount of goods purchased will be included as an addition in the calculation of the cost of goods sold (COGS).
| COGS = Ending inventory – Beginning inventory + Purchases |
On the other hand, if we use the perpetual inventory system, we can make the journal entry for purchasing goods on credit by debiting the inventory account instead of the purchases account and crediting the accounts payable.
| Account | Debit | Credit |
|---|---|---|
| Inventory | 000 | |
| Accounts payable | 000 |
In this journal entry, we debit the costs of purchasing goods directly to the inventory account because, under the perpetual inventory system, we need to update the balance of the inventory account perpetually. This means that when we purchase the inventory goods in, we need to record it as an increase in the inventory account immediately.
Later, when we make the cash payment for the goods that we purchased on credit, we can make another journal entry for the cash payment by debiting the accounts payable and crediting the cash account.
| Account | Debit | Credit |
|---|---|---|
| Accounts payable | 000 | |
| Cash | 000 |
This journal entry will remove the amount of the accounts payable that we have recorded for purchasing goods on credit previously as we make the cash payment to the supplier. Likewise, this journal entry for settling previous credit purchases of the goods will decrease both total assets and total liabilities on the balance sheet by the same amount.
Purchasing goods on credit example
For example, on January 1, we purchase $10,000 of goods on credit from one of our suppliers. Later, on February 1, we make a $10,000 cash payment to settle this credit purchase of goods.
What is the journal entry for purchasing these $10,000 goods on credit?
- if we use the periodic inventory system
- if we use the perpetual inventory system
Solution:
Periodic inventory system
If we use the periodic inventory system, we can make the journal entry for purchasing the $10,000 goods on credit on January 1, by debiting the $10,000 of goods to the purchases account and crediting the same amount to accounts payable as below:
January 1:
| Account | Debit | Credit |
|---|---|---|
| Purchases | 10,000 | |
| Accounts payable | 10,000 |
Perpetual inventory system
If we use the perpetual inventory system, we can make the journal entry for the $10,000 goods purchased on credit by debiting the inventory account instead of the purchases account as below:
January 1:
| Account | Debit | Credit |
|---|---|---|
| Inventory | 10,000 | |
| Accounts payable | 10,000 |
This journal entry will increase both total assets and total liabilities on the balance sheet by $10,000 for purchasing the $10,000 goods on credit.
Later when we make the $10,000 cash payment to the supplier in order to settle the goods purchased on credit, we can make the journal entry to remove the $10,000 amount from the accounts payable as below:
| Account | Debit | Credit |
|---|---|---|
| Accounts payable | 10,000 | |
| Cash | 10,000 |
This journal entry will decrease the total assets by $10,000 as a result of the $10,000 cash outflow from the business. And at the same time, it will also decrease the total liabilities on the balance sheet by the same amount as we settle the $10,000 debt from the credit purchase of goods we made previously.
Purchasing goods in cash
On the other hand, if we purchase the goods using cash, we will credit the cash account instead as a result of the cash outflow from our business.
Likewise, we can make the journal entry for purchasing goods in cash by debiting the purchases account and crediting the cash account if we use the periodic inventory system.
| Account | Debit | Credit |
|---|---|---|
| Purchases | 000 | |
| Cash | 000 |
Alternatively, if we use the perpetual inventory system, we can debit the inventory account and credit the cash account for the purchase of goods in cash journal entry.
| Account | Debit | Credit |
|---|---|---|
| Inventory | 000 | |
| Cash | 000 |
For example, assume that, on January 1, we purchase the $10,000 goods in cash instead of purchasing them on credit.
If that is the case, we can make the journal entry for the purchase of $10,000 goods in cash for both the periodic inventory system and perpetual inventory system as below:
Periodic inventory system:
| Account | Debit | Credit |
|---|---|---|
| Purchases | 10,000 | |
| Cash | 10,000 |
Perpetual inventory system:
| Account | Debit | Credit |
|---|---|---|
| Inventory | 10,000 | |
| Cash | 10,000 |