For companies in the manufacturing or retail industry, inventory is the primary tool to generate revenues. These companies acquire or create goods they can sell further for a profit. Usually, the process begins with obtaining the required goods that the company can put for sale. Sometimes, it may also involve processing or converting the acquired items.
What is Inventory?
Inventory refers to goods, raw materials, or products companies use to generate revenues. Sometimes, it may also include intangible assets. The primary purpose of inventory within a business is to sell to customers in exchange for compensation. Inventory is a part of the balance sheet in accounting, where it appears under current assets.
For most manufacturing companies, inventory includes raw materials, work-in-progress and finished goods. Usually, companies acquire raw materials from a supplier. Then, they work on the obtained items to convert them to finished goods. Until it reaches that stage, the inventory is known as a work-in-progress.
What are Inventory Purchases?
Inventory purchases refer to the process used to acquire inventory from suppliers. For companies, it involves finding an appropriate supplier that offers competitive prices. Once selected, the company can place an order with the supplier for any amount of goods required. The supplier then processes the order and delivers the goods to the company.
Inventory purchases may also refer to the account maintained to record acquired inventory. While the inventory account appears on the balance sheet, inventory purchases are a part of the income statement. There, it plays a crucial role in calculating the cost of goods sold. The inventory purchases account holds details of all inventory acquisitions during a single accounting period.
How to calculate Inventory Purchases?
Usually, companies record every goods acquisition transaction in the inventory purchases account. The closing balance on that account at any time constitutes the inventory purchases for that period. Alternatively, companies can also use a formula to calculate the amount, which is as below.
Inventory purchases = Closing inventory – Opening inventory + Cost of goods sold
What is the journal entry for Inventory Purchases?
The journal entry for inventory purchases may include two steps. The second step does not relate to the acquisition process. However, it is a part of the process of acquiring inventory.
When a company acquires inventory, it may do so on credit from the supplier. The journal entry at this stage is as follows.
| Dr | Inventory purchases |
| Cr | Accounts payable |
If the company pays cash instead of obtaining credit, the credit side of the entry will be the cash account. On top of that, the second stage is not necessary since the cash transaction closes the cycle. If the transaction occurs on credit, the company must repay the supplier later. At this point, the company will record the compensation as follows.
| Dr | Accounts payable |
| Cr | Cash or bank |
Conclusion
Inventory refers to goods held by a company for processing and selling. Usually, it includes raw materials, work-in-progress and finished goods. The inventory cycle within a company starts with inventory purchases. Usually, it involves acquiring goods from relevant suppliers. These purchases become a part of the income statement and can also impact the balance sheet.
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