Is Purchase Debit or Credit?
Is purchase debit or credit? Purchase is an expense that is included on the income statement within the cost of goods sold if it is incurred for purchasing raw materials that are used in the manufacturing process. Every company that is in existence has had reasons for purchasing equipment, inventory, or assets that aid in their day-to-day operation. When companies make a purchase, they have two options; paying immediately or paying afterward. If the company pays immediately, the purchase is termed a cash purchase. If the company pays afterward, the purchase is termed a credit purchase.
Here, we shall discuss both cash and credit purchase in order to ascertain whether a purchase is a debit or credit.
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Understanding purchase
A purchase is the acquisition of goods or services in exchange for cash or credit payment. Purchases could also be a barter transaction where the parties involved exchange a good for a service or vice-versa. Purchases are a big part of the manufacturing process as raw materials that are processed into finished goods must be purchased. Hence for manufacturing companies, their purchases involve buying raw materials that will be used in the production of goods. For retail companies, their purchases involve buying finished goods from manufacturers which they later resale.
In accounting, the purchase is the cost of acquiring inventory with the aim of reselling them or purchasing assets that ease business operations. When goods or inventory is purchased, it is recorded on the company’s income statement as part of the cost of goods sold or supplies expense. When assets such as land, building, machinery, plant, and other assets are purchased, they are recorded on the balance sheet as fixed assets.
Although both the purchase of supplies and inventory result in the reduction of the company’s assets, accounting for them is not the same. Supplies are items companies use for their day-to-day operations such as highlighters, paper, pens, trash cans, etc. Supplies aid the company’s employees to perform their tasks more efficiently. They usually have a finite life span due to their use.
Inventory comprises items that companies produce or purchase to sell to customers. These include the raw materials and components, repair and operating supplies, finished goods and maintenance, and work in progress. Supplies and inventory have to be properly accounted for because the company usually pays sales tax for supplies while inventory is taxed when they are sold to the customer.
As mentioned earlier, purchases can be either in cash or on credit. Let us have a brief look at each of these ways through which companies make purchases and the varying journal entries for the purchase of supplies and inventory.
Debit and credit journal entries for purchase
When companies purchase supplies or inventory, they either pay in cash or make the purchase on credit. For either of these purchases, a debit and credit journal entry has to be made in order to record the transaction. In order to accurately make such journal entries, the supplies or inventory account are often used to record the purchase of supplies or inventory respectively.
The double-entry accounting method is used to record purchases made by a company. With this method, a debit to one account is followed by a credit to another account. The entries are usually equal but opposite; this means that when one account reduces, another increase. This ensures that the company has a balanced and accurate financial report. Let us have a look at the cash and credit purchase as well as the various journal entries for the purchase of supplies and inventory.
Cash purchase
A cash purchase refers to when a company pays for goods, services, or assets immediately. Although it is termed a cash purchase, it does not necessarily mean the company pays for its purchase using dollar notes. Cash purchases also include payments made by cheques, bank transfers, card payments, cryptocurrency, etc.
The key factor that qualifies a purchase as a cash purchase is that the payment is made immediately after the purchase is made. When a cash purchase is made, two accounts are involved; the purchase account and the cash account. The purchase account is debited to signify the increase in expense while the cash account is credited to signify a decrease in assets. This transaction is normally recorded in the company’s cash ledger.
Assuming Tesla purchases $1,000,000 worth of office supplies and paid the supplier via a bank transfer; the company will record the purchase of the supplies as a debit to the supplies expense account and a credit to the cash account. The journal entry will be shown below:
Debit and credit journal entry for cash purchase of supplies
| Account | Debit | Credit |
|---|---|---|
| Supplies expense | $1,000,000 | |
| Cash | $1,000,000 |
Although the office supplies were paid for by bank transfer, the journal entry records the payment as cash because the transfer was made immediately after the purchase was made and represents a reduction in the company’s cash in the bank.
The journal entry for the cash purchase of inventory is similar to that of supplies, it involves a debit to the inventory account and a credit to the cash account. For instance, if a bag manufacturing company such as Tetrafab purchases a thousand bales of leather for its bag production. Assuming the purchase cost $100 per bale and they paid in cash, the journal entry to record this purchase will be as the one below:
Debit and credit journal entry for cash purchase of inventory
| Account | Debit | Credit |
|---|---|---|
| Inventory | $100,000 | |
| Cash | $100,000 |
Since each bale of leather cost $100, it means they paid $100 x 1000 or $100,000 for the purchase of the leather. The purchase is further made under inventory since leather is the raw material for the production of bags.
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Credit purchase
Credit purchase is the opposite of cash purchase. In this case, the company does not pay for the supplies or inventory they purchased immediately. Instead, they pay within 30 days or earlier or later than 30 days depending on the credit terms as stipulated on the purchase invoice.
For purchases on credit, a debit is made to the supplies or inventory account and a credit is made for the accounts payable. As such, transactions for purchases made on credit are recorded in the company’s payable ledger. The accounts payable records all that the company owes or has to pay to creditors.
For example, if a company purchases pens worth $740 that will be used by employees in the office but did not pay for the pens immediately, the purchase will be recorded as shown below:
Journal entry for the purchase of supplies on credit
| Account | Debit | Credit |
|---|---|---|
| Supplies | $740 | |
| Accounts payable | $740 |
The purchase of pens is recorded as supplies because the pens are items that will be used by the company’s employees in daily business operations.
When a company makes a purchase on credit for inventory. It is recorded as a debit to inventory and a credit to accounts payable. For instance, if a clothing retail company buys clothes worth $220,590 from an haute couture manufacturer and they are expected to pay within 90 days. The retail company will record the transaction as seen in the table below.
Debit and credit journal entry for the purchase of inventory on credit
| Account | Debit | Credit |
|---|---|---|
| Inventory | $220,590 | |
| Accounts payable | $220,590 |
Since the retail company purchased the clothes with the aim of selling them off to make a profit, the purchase is classified as inventory hence it is recorded as a debit to inventory and a credit to accounts payable.
Journal entry for payment of inventory that was purchased on credit
For both the purchase of supplies and inventory, once the company pays up its debt, the transaction will be recorded as a debit to the accounts payable and a credit to cash. Continuing the example above, when the clothing retail company pays up its debt to the haute couture manufacturer, the following journal entry will be made to record the transaction.
| Account | Debit | Credit |
|---|---|---|
| Accounts payable | $220,590 | |
| Cash | $220,590 |
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Is purchase a debit or credit?
Purchases whether paid in cash or taken on credit to be settled later both led to a reduction in the company’s assets and an increase in its expenses. Hence, the expense is debited while assets are credited. Accounting for the purchase of both supplies and inventory requires that a debit be made to either the supplies expense or inventory account depending on whether what has been purchased is considered supplies or inventory.
Since all purchases must be paid either immediately or after some time, it means the company’s cash will decrease while the account for what was purchased will increase. Hence purchase is always recorded as a debit to the supplies expense or inventory account and a credit to cash or accounts payable. We can therefore conclude that purchase is a debit and not a credit.
