Credit Purchase and Cash Purchase
Purchase is the process of buying a product or service which starts from making the request, receiving goods, and making payment. An effective Purchase system will help the company to filter unnecessary transactions and only important requests are approved. It also helps to select the best quality product and a reasonable price.
For big entities, they will set up a purchasing department to handle this working process. Purchase cover from fixed asset acquisition, raw material, office supply, tools, and so on. They are working very closely with the accounting department. The accountant needs information regarding goods arrival while purchasers need to follow up with the accountant regarding the payment to suppliers.
Credit Purchase
Credit Purchase is the purchase which we acquire goods or services immediately and promise to pay in the future. In daily operation, not all purchases will require to pay immediately. Some purchases need to be made on credit as the operation requires material and payment can be made later. Moreover, it is a business strategy of suppliers to gain trust from customers by allowing them to consume goods/services and pay later.
Customers need to record the transaction even the payments are not yet made due to the accrual concept. The accountant must record expenses/assets with accounts payable which will be settled later.
Credit Purchase Journal Entry Example
On 01 May 202X, Company ABC purchases $100,000 of raw material on credit from the suppliers. On 07 May, the material arrives at the production site.
On 25 May, ABC may full payment to the suppliers. Please prepare journal entries for the relevant transactions.
- 01 May, we do not need to record anything like the material not yet arrived, we do not have any obligation to pay for the supplier. The inventory is not yet arrived, so the company does not have any ownership. The risk and reward are not yet transferred to the company as well.
- 07 May, we need to record material as the risk and reward has been transferring and we also have obligation to pay the supplier. The company makes journal entries by debiting inventory of $ 100,000 and credit accounts payable of $ 100,000.
| Account | Debit | Credit |
|---|---|---|
| Inventory-material | 100,000 | |
| Accounts Payable | 100,000 |
This transaction will increase inventory in balance sheet, and it allows the company to withdraw material for manufacturing. And it will transfer as the production process. At the same time, company record accounts payable which is the obligation to settle with the supplier in the future. If the supplier does not send an invoice yet, ABC needs to accrue the balance based on the purchase order or agreement. We will not record accounts payable but accrue payable, it will allow us to recognize inventory.
- On 25 May, we need to record cash out and clear accounts payable. ABC use cash to settle the accounts payable, we need to debit accounts payable $ 100,000 and credit cash $ 100,000.
| Account | Debit | Credit |
|---|---|---|
| Accounts Payable | 100,000 | |
| Cash | 100,000 |
The company uses cash to settle accounts payable, so the amount of cash will decrease as well as the liability. The transaction will reduce both items from balance sheet.
Cash Purchase
Cash Purchase is the process when company buy goods or service and make payment immediately. Not all suppliers are willing to take risks by selling on credit. It mostly happens when the suppliers have strong bargaining power in the market. They are less likely to take care of customers especially the small buyers. For the buyer, they are going to pay immediately for the small purchase which is not impacting their cash flow. Most of the company has petty cash to pay for such kinds of transactions.
Cash Purchase Journal Entry Example
For example, Company ABC purchases office suppliers, due to the small amount, accounts decide to go and buy directly from the supper market. The total purchase is only $50 and she paid by using the petty cash. Please prepare a journal entry for this transaction.
The transaction is the cash purchase in which accountants use petty cash to pay for office supplies. It can happen in daily operations when the company needs to buy urgent items that are not applicable to ask for credit. Sometimes the amount is very small so it is not necessary to request for credit term.
ABC company simply debits the office supplies and credits petty cash $ 50. The office supplies will record as expenses in the income statement and cash is reduced from the balance sheet.
| Account | Debit | Credit |
|---|---|---|
| Office Supplies | 50 | |
| Petty Cash | 50 |
