What is the Purchases Account?

Purchases Account

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Purchases Account

The Purchases Account is an account used in the periodic inventory system that records all purchases made by a business during a specific period, typically a fiscal year. This includes all inventory items purchased for resale, as well as any freight or transportation costs associated with getting the goods to the business location.

The Purchases Account is a temporary account that is closed at the end of the accounting period. It is debited for each purchase transaction and credited for returns, allowances, or purchase discounts. The balance of the Purchases Account is then used to calculate the Cost of Goods Sold (COGS) at the end of the period.

It’s important to note that the Purchases Account is used in the periodic inventory system, which updates inventory balances at the end of each period based on a physical count. It is not used in the perpetual inventory system, which updates inventory balances continuously as purchases and sales occur.

The Purchases Account helps businesses to keep track of how much they are spending on inventory, which is a major expense for many companies. It also provides a record of all purchase transactions, which can be useful for budgeting, financial analysis, and audit purposes.

Example of the Purchases Account

Let’s consider a bookstore named “Books Galore” that uses a periodic inventory system. They started the year with an inventory worth $10,000.

Over the course of the year, they made several purchases to restock their inventory:

  • In January, they purchased $3,000 worth of books.
  • In April, they purchased another $2,000 worth of books.
  • In August, they purchased $1,500 worth of books.
  • In November, they purchased $3,500 worth of books.

Each time a purchase is made, Books Galore would debit (increase) their Purchases Account by the amount of the purchase. By the end of the year, the balance of the Purchases Account would be:

$3,000 (January purchases) + $2,000 (April purchases) + $1,500 (August purchases) + $3,500 (November purchases) = $10,000

This $10,000 represents the total amount spent on inventory purchases throughout the year.

Now, if Books Galore wanted to calculate their Cost of Goods Sold (COGS) for the year, they would add their beginning inventory to their purchases, and then subtract their ending inventory:

COGS = Beginning Inventory + Purchases – Ending Inventory

If their ending inventory (calculated by a physical count at the end of the year) is $8,000, their COGS would be:

COGS = $10,000 (Beginning Inventory) + $10,000 (Purchases) – $8,000 (Ending Inventory) = $12,000

This calculation shows that Books Galore sold $12,000 worth of books during the year. The Purchases Account, therefore, plays a critical role in tracking the bookstore’s inventory spending and calculating their COGS.

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