Journal Entry for Credit Purchase
Purchase is the process of getting goods or services for the company for business purposes. The company needs to spend money to settle with suppliers in order to obtain the goods or enjoy the service. In business, supplier allows the company to obtain the goods and services first and pay later. It is called a credit purchase.
Credit purchases will help the company to increase sales to the big customers. These customers will buy in bulk quantity and they looking for the suppliers with good credit terms. Most of them are resellers and manufacturers who need time to convert the inventory to cash as well. So when sellers allow them to purchase on credit, they will be able to purchase and increase their operation. It is a huge benefit for the customers who run the business operation. Their capital is very limited, so with the credit purchase, they will be able to resell the products and get money to pay back to the supplier.
The company can use credit purchases over a huge scope such as raw material, fixed assets, other expenses, and so on. As we know the assets and expenses will increase on the debit side and liability will increase on the credit side. So the transaction related to credit purchase will credit liability and debit various accounts depending on the nature of the purchase.
Credit purchases will generate liability for the company. It is the future obligation which they need to pay suppliers in the future. These are the current liabilities as the company needs to pay within a year. Suppliers are not willing to let their customers take the credit for more than a year.
Journal Entry for Credit Purchase – Inventory
The retailer will purchase the inventory from the manufacture and put them in the stores. They will sell those products to the consumer.
The manufacture purchase many types of raw materials based on their production process. They will convert those materials to finished goods based on their skills.
Both companies need to record inventory and account payable when they purchase on credit. The journal entry is debiting inventory and credit accounts payable.
| Account | Debit | Credit |
|---|---|---|
| Inventory | $$$ | |
| Accounts Payable | $$$ |
Inventory accounts will be increased on balance sheet under the current assets section. The company may use a subaccount of inventory such as raw material, type of goods, and so on. It depends on the nature of the business the detail control. However, they all will be total as inventory on the balance sheet.
Example
Company ABC purchase $ 50,000 of raw material on 01 April. Due to a long relationship with supplier, the company receive the credit term for 30 days. On 30 April, ABC pay the full amount to the supplier. Please prepare the journal entry for both transactions.
On 01 April, company purchase the inventory on credit. Accountant should make journal entry by debiting inventory (raw material) and credit accounts payable.
| Account | Debit | Credit |
|---|---|---|
| Inventory_Raw Material | 50,000 | |
| Accounts Payable | 50,000 |
The company must record inventory into balance sheet when risk and rewards are transferred. At the same time, it must recognize the obligation to settle with supplier.
On 30 April, the company pay cash to settle the accounts payable, so they make the journal entry by debiting accounts payable and credit cash.
| Account | Debit | Credit |
|---|---|---|
| Accounts Payable | 50,000 | |
| Cash at bank | 50,000 |
Journal Entry for Credit Purchase – Fixed Assets
The company may purchase fixed assets to support its operation. Similar to inventory, the suppliers will provide credit purchases to boost their sale quantity.
The company needs to record fixed assets and accounts payable. Fixed assets will be recorded into the balance sheet when three criteria are met:
- The cost measure reliable
- Fixed assets ready to use
- Fixed assets expect to generate future benefits for the entity.
When all these criteria meet, company makes a journal entry by debiting fixed assets and credit accounts payable.
| Account | Debit | Credit |
|---|---|---|
| Fixed Assets | $$$ | |
| Accounts Payable | $$$ |
The transaction will increase the fixed assets on balance sheet in assets section. And it also increases the accounts payable under the current liability section.
Eample 2
Company XYZ purchases a machine for the production process which costs $ 100,000 on 01 March. The supplier will take full responsibility to deliver the machine to XYZ, it arrives on 05 March with proper testing. However, the company did not start using the machine due to a lack of staff. They officially use the machine on 01 April. Please prepare journal entry to record fixed assets.
When company purchases fixed assets on credit, they need to debit fixed assets and credit accounts payable. The problem is when we should record the transaction. We should look back at the criteria to recognize assets. When placing the order, we already know the actual cost of the machine. The supplier is responsible to deliver to the machine, so the risk is transferred when the machine arrives. And it is already ready to use even the company did not use it due to other reasons.
So on 05 March, company make journal entry by debiting fixed assets and credit accounts payable $ 100,000.
| Account | Debit | Credit |
|---|---|---|
| Fixed Assets | 100,000 | |
| Accounts Payable | 100,000 |
Journal Entry for Credit Purchase – Expense
Besides assets, company can purchase the expense on credit. They purchase goods or services from the suppliers and record them as expenses such as consulting fees, office supplies, insurance services,s and so on.
The journal entry is an expense on the debit side while current liability is on the credit side.
| Account | Debit | Credit |
|---|---|---|
| Expense | $$$ | |
| Accounts Payable | $$$ |
The expenses will be present in the income statement and reduce the company profit. The expense may fall under different accounts due to the nature of the transaction.
Journal Entry to Settle Accounts Payable
These three types of purchases on credit will increase inventory, fixed assets, expense, and accounts payable.
Inventory, fixed assets, and expenses will be treated based on other accounting standards. For the accounts payable, it needs to reverse back when company settles with the supplier.
Within the credit term, customers need to settle with the seller. The company needs to pay cash to settle, so the journal entry is debiting accounts payable and credit cash.
| Account | Debit | Credit |
|---|---|---|
| Accounts Payable | $$$ | |
| Cash | $$$ |
This transaction will eliminate accounts payable from the balance sheet and reduce cash by the same amount.
