Recording Purchases Using the Perpetual System

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  • 0:01 Sales Defined
  • 0:22 Double Entry Accounting
  • 1:53 Recording Purchases
  • 5:32 Lesson Summary
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Lesson Transcript
Instructor: Rebekiah Hill

Rebekiah has taught college accounting and has a master's in both management and business.

Every transaction that occurs in a business, whether it is a purchase or a sale, must be accounted for. In this lesson, you will learn how to record purchases using the perpetual inventory system.

Perpetual System Defined

Sarah is in the process of opening her own business. Today, she's going to get her inventory ordered. With the help of her accountant, she has already decided what type of inventory system to use to help her keep a check on the comings and goings in her inventory. Because a perpetual system is an inventory system that continually updates the inventory account with each purchase and sale, it's the system Sarah has chosen.

Double Entry Accounting

But she really wants to understand a little more on how to record transactions in her accounting books, so let's see if we can help her.

The first thing that Sarah needs to know is that transactions are recorded based on the double entry accounting system. This system requires that for every one transaction that occurs in a business, at least two accounts are affected. One account is debited, and one account is credited.

A debit is an entry on the left side of an account that increases the balance in asset accounts and decreases the balance in liability and equity accounts. A credit is an entry on the right side of an account that decreases the balance in an asset account and increases the balance in liability and equity accounts.

Why are debits and credits important? Well, the answer to that question is very important. The entire concept of accounting is based on one equation, called the accounting equation. The accounting equation states that assets = liabilities + owner's equity. Assets are something that a business owns, liabilities are something that a business owes, and owner's equity is the amount of money that the business owner has personally invested into the business.

No matter what happens in the course of an accounting period, the accounting equation must always be kept in balance. That occurs by debiting one account and crediting another.

Recording Purchases

The best way to really get the point across about recording purchases is to do just that, so let's look at some examples.

Let's say that Sarah orders $5,000 in merchandise inventory and pays for it in cash. How would she record this transaction in her accounting records?

Let me give you a few hints. There are two accounts that are affected in this transaction. Since she purchased merchandise inventory, then the inventory account balance needs to increase. She paid for her purchases with cash. This means that the balance in her cash account decreases. Since both of these accounts, inventory and cash, are something that the business owns, they are asset accounts.

To increase the balance in an asset account, that account is debited. To decrease the balance in an account, that account is credited. So now that I have given you these clues, what do you think should be done? Well, I hope you answered debit the inventory account and credit the cash account. But let me show you how this looks in the actual accounting ledger.

On the first line, you put the date (Dec 1) followed by the account (which the first account is inventory) and the debit amount (which is $5000). On the second line, you put cash, the account that is credited, followed by the the amount that is credited ($5000):

Date Account Debits Credits
Dec. 1 Inventory $5,000
Cash $5,000

Now, what if the merchandise was not paid for in cash, but was bought on account? On account means that Sarah takes ownership now and agrees to pay for the merchandise at a later date. Anything that is bought on account creates an accounts payable. Because an accounts payable is something that Sarah owes, then it's a liability account. In order to increase the balance in a liability account, that account must be credited. The inventory account will also increase with this transaction. So once again, since inventory is something that a business owns, it is an asset account, and must be debited to increase its balance. With that being said, how do you think Sarah should record the purchase of inventory on account?

I hope that you said that the inventory account should be debited $5,000, and the accounts payable account should be credited $5,000. In this case, the general ledger entry would look like this:

Date Account Debits Credits
Dec 1 Inventory $5,000
Accounts Payable $5,000

Now, what happens when Sarah pays on the account?

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