Purchase

Purchase

 Purchase in accountancy is anything that you take as a possession for the purpose of running a business or for production. It is the process of transferring ownership over a product or a service in exchange for a predetermined monetary amount. It can be an asset, item or property or gain rights by paying the monetary amount to complete a transaction.  

What do you mean by Purchase? 

In accounting terms, a purchase is a process in which the individual or business incurs the cost to buy an inventory of goods for production or operations or resale in the course of the business activities during the accounting period. It is an operation carried out routinely in various businesses. Once the owner gains rights to the product/service, they can dispose of it as per their willingness.  

The purchase activity is a much more formal procedure in a corporate setup. A small petty Purchase is less complex than a more significant Purchase, as those require analysis. Businesses can make these Purchases in cash as well as in credit. Purchases are an expensive treatment and are a part of the income statement within COGS [cost of goods sold].  

In the financial statements, any purchase made by the business increases the expenditure and decreases the company’s assets [current]. The effect of the Purchase of books of account is such that the expense is debited while the assets are credited. Along with that, there is an increase in the inventories of the business. But, the Purchase does not include the inventory here.  

 Types of Purchases 

The Purchase has a different meaning for various kinds of businesses. Like a retail business, Purchase caters to buying finished products for resale. Whereas, for manufacturing, businesses’ purchase is a part of acquiring raw materials for production.  

Purchase made in the business has many phases. As mentioned above, purchases can be made for raw materials or resale of finished products, depending on the industry type. 

Purchase is also made when we acquire fixed assets for the business. Fixed assets may include – plants, buildings, factories, vehicles or even land. These purchases increase the holdings of the company. These purchases are capitalised in the books of accounts created during the accounting year. Instead of being considered expenses, the Purchase of fixed assets is counted as procurement of assets in the trading, profit and loss account.  

 Nature of Purchases 

A purchase occurs when a seller and buyer agree on a specific price for any products or service marked at a predetermined amount within the market environment. This Purchase can take place only in monetary terms – which includes cash and credit transactions. On the one hand, cash purchase occurs when the buyer is ready to make the payment immediately. On the other hand, a credit purchase is when the buyer has transferred the ownership. Still, he pays the product’s total monetary value within a specified period – as mutually decided by the buyer and seller during the initial stage.  

A cash purchase occurs in the market when the buyer agrees to pay the total value of the product or the service in totality at the time of transfer of ownership. Cash purchase often takes place when the products or service is ready or fully prepared at the time of purchase. It is common in the retail industry, as the goods and services are primarily ready-made, and traders can immediately transfer ownership. While, in a manufacturing type of business – the products are usually prepared after order. Therefore, it usually doesn’t undergo a cash purchase.   

Treatment of cash and credit purchase 

  For a cash purchase, double-entry is passed in the books of accounts. First, the purchase account is a nominal account debited in the income statement. Then, the cash is a real account credited [as we cash goes out of the business]. The purchase account is debited as the expenses of the business increase. While the cash account is credited because cash is a current asset for the business, and it decreases after the payment is made for the products/services.

Again, a double entry is made in the financial statements for credit purchases. The purchase account is also first debited because it is a nominal account. The difference is that instead of a cash account, we credit the creditor’s account [creditor – is the individual/ business from whom we are making the Purchase on credit]. Purchase is debited as the expense side of the business increases. At the same time, the creditor account is also increased as the credit to the business increases. The creditor’s account is debited at the time of payment to the creditor, and the cash account is credited. Here, as we are closing our old debts and reducing the liabilities, we debit the creditor’s account and decrease our current assets [cash], which is why we credit it.  

 In the end, we can say that Purchase is an integral part of business activities. That active part occurs daily for any business, whether big or small. However, the nature and method of Purchase vary for every business. Whether government or private, every company has to make a purchase; the quantity and quality may differ. Therefore, the Purchase is a crucial part of financial accounting.