Purchases (Accounting)

Purchases, in accounting, is a general ledger account that records the cost of merchandise a business buys in order to resell it. It is used by retailers, wholesalers and distributors that keep their stock records under a periodic inventory system. Each time goods are bought, the cost is debited to purchases rather than directly to inventory, and the account builds up over the accounting period until it is closed at year end.

Purchases is a temporary account with a normal debit balance. It does not appear on the balance sheet. Instead, it is one of the building blocks of cost of goods sold on the income statement, together with beginning and ending inventory and several related accounts that adjust it, such as purchase returns, purchase discounts and freight-in.

When a business places a purchase order and receives goods with a supplier's invoice, the bookkeeper records the cost in the purchases account. If the goods are bought on credit, the entry is a debit to purchases and a credit to accounts payable. If the goods are paid for at once, cash is credited instead. Several contra and adjunct accounts are kept alongside it:

• Purchase returns and allowances records goods sent back to the supplier or price reductions for damaged items. It has a credit balance and reduces purchases.
• Purchase discounts records reductions for paying early, for example under terms of 2/10, net 30. It also has a credit balance.
• Freight-in records the cost of shipping goods to the buyer's premises. It is added to purchases because it is part of the cost of getting the goods ready for sale.

Purchases less returns and discounts gives net purchases. Adding freight-in gives the cost of goods purchased.

A hardware shop starts the year with inventory of $40,000. During the year it buys $310,000 of goods on credit, returns $6,000 of faulty stock, takes $4,000 of early payment discounts and pays $9,000 in inbound freight. A physical count at year end shows inventory of $52,000. The calculation of cost of goods sold is:

Here $\text{Beginning inventory}$ is stock on hand at the start of the period, $\text{Cost of goods purchased}$ is net purchases plus freight-in, and $\text{Ending inventory}$ is the stock counted at the end. Net purchases are $310,000 minus $6,000 minus $4,000, or $300,000. Adding freight gives $309,000. The cost of goods available for sale is $40,000 plus $309,000, or $349,000. Subtracting ending inventory of $52,000 leaves cost of goods sold of $297,000.

Because purchases is a temporary account, its balance is reduced to zero at the end of each period as part of the closing process. Under one common approach, the closing entries remove the beginning inventory balance and the balances of purchases, returns, discounts and freight-in, record the counted ending inventory in merchandise inventory, and put the difference into cost of goods sold or the income summary account. The new year then starts with a purchases balance of zero.

Businesses that use a perpetual inventory system do not normally use a purchases account at all. They debit the inventory account directly when goods arrive and credit inventory, while debiting cost of goods sold, each time an item is sold. Returns, discounts and freight are also posted straight to inventory. Most larger businesses now use perpetual records because point-of-sale and warehouse software makes them practical, but the purchases account is still widely taught and used by small firms. The word purchases is also used informally for any acquisition, such as equipment, but those are recorded as assets or expenses, not in the merchandise purchases account.