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Accounting for Purchases and Accounts Payable Chapter 8 Accounting for Purchases and Accounts Payable Section 1: Merchandise Purchases Section Objectives Chapter 7 discussed the use of a sales journal and the relationship of a control account to it subsidiary accounts. Chapter 8 discusses purchases and the purchases journal. In section one of the chapter we will learn how a merchandiser accounts for the purchases it makes of the merchandise it will later sell. Objective one illustrates how to record purchases of merchandise on credit in a three-column purchases journal. 8-1 Record purchases of merchandise on credit in a three-column purchases journal. 8-2 Post from the three-column purchases journal to the general ledger accounts.

Purchasing Procedures The Sales Department sends an authorized purchase requisition to the Purchasing Department The Purchasing Department issues an authorized purchase order and sends it to the selected supplier A receiving report is prepared when the merchandise is received Most merchandising businesses purchase goods on credit under open-account arrangements. In a small firm, purchasing activities are handled by a single individual, usually the owner or manager. In a larger company, a centralized purchasing department may exist. For good internal control, normally three departments will be involved in purchasing merchandise for a company. You should study basic internal documents that are needed in the purchasing department and become familiar with them. These documents include a purchase requisition, a purchase order, a receiving report, and an invoice. The Accounting Department receives the invoice and copies of the purchase order and receiving report 8-3

Wow! I need to order more inventory! The Purchases Account Wow! I need to order more inventory! QUESTION: What is the Purchases account? The Purchases account is an account used to record cost of goods bought for resale during a period. ANSWER: A merchandiser has a an account called Purchases. The purchases of merchandise for resale is a cost of doing business. When a business buys merchandise, it debits an account called “Purchases.” 8-4

The Freight In Account What is the Freight In account? QUESTION: What is the Freight In account? The Freight In account is an account showing transportation charges for items purchased. It is also called Transportation In account. ANSWER: Businesses also usually pay shipping charges for much of the inventory items they purchase. The account Freight In or Transportation In is used to keep track of freight charges for merchandise we purchase. There are two ways to handle freight charges paid by the buyer: The buyer is billed directly by the transportation company for the freight charge. The buyer issues a check directly to the freight company. The seller pays the freight charge and includes it on the invoice. The invoice includes the price of the goods and the freight charge. 8-5

Record purchases of merchandise on credit in a three-column purchases journal Objective 8-1 Let’s record some purchases in the special three-column purchases journal. It is important to write the detail information about the vendor name and invoice number for reference later. In the Accounts Payable Credit column, enter the total owed to the supplier. 1. Enter the date, supplier’s name, invoice number, invoice date, and credit terms. 2. In the Accounts Payable Credit column, enter the total owed to the supplier. 8-6

Recording Purchases In the Purchases Debit column, enter the price of the goods purchased. In the Freight In Debit column, enter the freight amount. Also remember, debits must equal the total of the credits when entering transactions in a special journal. 3. In the Purchases Debit column, enter the price of the goods purchased. 4. In the Freight In Debit column, enter the freight amount. 8-7

Examples of Credit Terms Net 30 days or n/30: Payment in full is due 30 days after the date of the invoice. Net 10 days EOM, or n/10 EOM: Payment in full is due 10 days after the end of the month in which the invoice was issued. 2% 10 days, net 30 days; or 2/10, n/30: If payment is made within 10 days of the invoice date, the customer can take a 2 percent discount. Otherwise, payment in full is due in 30 days. A business may be able to take advantage of an early payment discount if it pays the invoice within a certain period of time. Here are some examples of credit terms which a seller might give a firm on a purchase. Take a moment to review the most common ones. Cash discounts are given to encourage early payment. A cash discount is a discount offered by suppliers for payment received within a specified period of time. If the business pays within a period of time it may receive a “cash discount” called a purchase discount. 8-8

Posting Steps Post from the Purchases Journal to the general ledger in seven steps. Locate the Accounts Payable ledger account. Enter the date. Enter the posting reference. Enter the amount from the Accounts Payable Credit column in the purchases journal in the Credit column of the Accounts Payable ledger account. Compute the new balance and enter it into Balance Credit column. In the purchases journal, enter the accounts payable ledger account number under the column total. Repeat the steps for the Purchases Debit and Freight In Debit columns The Posting procedure is the same as in other special journals. 8-9

Advantages of a Purchases Journal Allows for the division of accounting work among different employees Strengthens the audit trail Records all credit purchases in one place Using the purchases journal saves time and effort by simplifying the initial entry of purchases and by eliminating repetitive postings to the general ledger. 8-10

Accounting for Purchases and Accounts Payable Chapter 8 Accounting for Purchases and Accounts Payable Section 2: Accounts Payable Section Objectives 8-3 Post credit purchases from the purchases journal to the accounts payable subsidiary ledger. 8-4 Record purchases returns and allowances in the general journal and post them to the accounts payable subsidiary ledger. 8-5 Prepare a schedule of accounts payable. 8-6 Compute the net delivered cost of purchases. 8-7 Demonstrate a knowledge of the procedures for effective internal control of purchases. 8-8 Record purchases, sales, and returns using the perpetual inventory system. Section 2 of the chapter continues the purchasing process and introduces the accounts payable subsidiary ledger. In objective 3 we will learn how to post credit purchases from the purchases journal to the accounts payable subsidiary ledger. 8-11

The Accounts Payable Ledger An accounts payable ledger is a subsidiary ledger that contains a separate account for each creditor. Many businesses use an accounts payable subsidiary ledger to track amounts owed, to whom they are owed, when they are due, and discount terms. This ensures that the firms will have enough cash to pay for obligations. Let’s review what an accounts payable subsidiary ledger looks like. It is similar to the accounts receivable subsidiary ledger discussed in the previous chapter. The accounts payable ledger has three money columns. The Balance column is presumed to contain credit amounts. Increases to the creditor’s account are recorded with credits. Decreases to the creditors account are recorded with debits. 8-12

Posting to The Accounts Payable Ledger Objective 8-3 Post credit purchases from the purchases journal to the accounts payable subsidiary ledger To keep the accounting records up to date, invoices are posted to the accounts payable subsidiary ledger every day. To keep the accounting records up to date, invoices are posted to the Accounts Payable Subsidiary Ledger every day. 8-13

Sorry, I didn’t like the color. Posting returns Objective 8-4 Record purchases returns and allowances in the general journal and post them to the accounts payable subsidiary ledger Sorry, I didn’t like the color. A purchase return is a return of unsatisfactory Goods previously purchased for resale. Sometimes we may return goods which we purchased. The seller may give us a purchase return or an allowance. Sometimes goods are returned because they did not meet specifications or because the customer simply didn’t like the goods. Sometimes a seller may grant an allowance towards the purchase price. When a business returns merchandise to a vendor, it makes the opposite entry of that of a purchase but instead of crediting the Purchases account, the firm uses a new account called purchases returns and allowances. 8-14

Prepare a schedule of accounts payable Objective 8-5 Prepare a schedule of accounts payable The total of the individual creditor accounts in the subsidiary ledger must equal the balance of the Accounts Payable control account. To prove that the control account and the subsidiary ledger are equal, businesses prepare a schedule of accounts payable. The schedule of accounts payable displays the balances of all vendor/creditor accounts. The total of all the vendor accounts will equal the total balance in the general ledger accounts payable control account. The schedule of accounts payable is particularly important to a business owner or accounts payable manager in keeping track of how much money the company owes and when that amount is due. An Aging of Accounts Payable is a report that shows when the amounts owed are due. 8-15

Schedule of Accounts Payable A comparison of the total of the schedule of accounts payable and the balance of the Accounts Payable account shows that the two figures are the same. The total of all vendor balances must equal the total in the accounts payable control account in the general ledger. We see here that the two amounts are the same. 8-16

Delivered Cost of Purchases $ 18,795 The net delivered cost of purchases for Maxx-Out Sporting Goods for January is calculated as follows. Purchases $ 17,540 Freight In 1,255 Delivered Cost of Purchases $ 18,795 Less Purchases Returns and Allowances 100 Net delivered cost of purchases is $18,695. Take a moment to review the calculation. Net Delivered Cost of Purchases $18,695 8-17

The objectives of the controls are to: Demonstrate a knowledge of the procedures for effective internal control of purchases Objective 8-7 The objectives of the controls are to: create written proof that purchases and payments are authorized, and ensure that different people are involved in the process of buying goods, receiving goods, and making payments. Internal controls are rules which a business has set up to safeguard its assets. 8-18

Effective systems have the following controls in place: 1. All purchases should be made only after proper authorization has been given in writing. 2. Goods should be carefully checked when received. They should then be compared with the purchase order and with the invoice received from the supplier. Effective systems have controls in place. Take a moment to review these internal controls related to the purchasing process. 3. The purchase order, receiving report, and invoice should be checked to confirm that the information reflected on the documents are in agreement. 8-19

4. The computations on the invoice should be checked for accuracy. 5. Authorization for payment should be made by someone other than the person who ordered the goods, and this authorization should be given only after all the verifications have been made. 6. Another person should write the check for payment. All of these controls insure that proper accounting is taking place. 7. Prenumbered forms should be used for purchase requisitions, purchase orders, and checks. Periodically the numbers of the documents issued should be verified to make sure that all forms can be accounted for. 8-20

Record purchases, sales, and returns, using the perpetual inventory system. Objective 8-8 Perpetual inventory systems update the inventory account for every purchase, sale and return. Using this type of system usually requires a large investment in point-of-sale systems. This can provide more control over inventory and allows for shortages to be investigated quickly. There are some differences in accounting. One is that the “merchandise inventory” account replaces the purchases, purchases returns, and freight in accounts used in a periodic system. Another journal entry is needed to record the cost of goods sold every time a sale is made. So far we have assumed that a periodic inventory system has been used to account for purchase transactions. When the periodic system is used, the inventory records are only updated when a physical inventory count is taken. The perpetual inventory system immediately updates the general ledger merchandise inventory account. One advantage is that greater internal control usually exists and shortages of inventory can be discovered and investigated quicker. The accounting journal entries using a perpetual inventory transactions is a bit more complicated. When a perpetual inventory system is used, an account called merchandise inventory replaces the purchases, purchases returns, and freight in accounts. The merchandise inventory account is an asset account whose balance represents the cost of merchandise inventory on hand. Additionally, perpetual inventory accounting requires a second entry when sales are made. This entry debits the Cost of Goods Sold account and credits the merchandise inventory account. The Cost of Goods Sold account is classified as an expense account. 8-21

College Accounting, 14th Edition Thank You for using College Accounting, 14th Edition Price • Haddock • Farina 8-22