Companies report sales information for investors to understand their operations better. This report comes through the income statement where companies can state how much revenues they made. Similarly, companies also provide information about the costs incurred to generate those sales. These costs also come under different headings. For example, these include the cost of sales, operating expenses, financial expenses, etc.
One of the prominent figures in the cost of sales is the purchases made by companies. However, not all items acquired by a company end up in this figure. Some companies deduct items from purchases to reach a net purchase figure. This figure is crucial in calculating the gross profits generated by companies. Therefore, it is critical to understand net purchases.
What are Net Purchases?
Net purchases refer to the total items purchased by a company after some adjustments. Usually, these adjustments include purchase discounts, purchase returns, and purchase allowances. Each represents a different financial transaction between a company and its suppliers. The accounting for net purchases also adjusts these items before reaching a final figure.
Net purchases are an amount reported in the notes to the financial statements. However, it is a crucial contributor to the cost of sales reported in the income statement. Through the notes, companies can expand those items. One of those items includes the net purchases figure. Usually, the lower this figure is, the better it is for companies in generating profits.
Primarily, companies must subtract their purchases from their revenues to reach gross profits. However, they must first adjust some figures, such as closing and opening inventory. Companies must also calculate the cost of sales by including other directly attributable expenses. However, purchases are usually the most prominent figure in presenting these costs. Before reporting purchases in this figure, companies must adjust other items.
These items include discounts, allowances, and returns. Each of these reduces the number of purchases a company makes. However, this process does not happen directly. These items occur after companies have already purchased from a supplier. Therefore, reducing the purchase figure through the accounts is not an allowable treatment. Instead, companies must adjust for these separately.
The accounting for net purchases also considers these reductions. There is no accounting treatment for net purchases directly in the books. However, companies can account for each element separately. The accounting treatment comes through the presentation of net purchases in the notes to the financial statements. Besides that, companies must record each item of the net purchases figure separately.
What are the Components of Net Purchases?
The net purchases figure in the financial statements includes four components. Usually, only purchases apply to every company. The other three components, discounts, allowances, and returns, may not be for every company. Nonetheless, these items contribute to calculating net purchases. An explanation of each of the components of net purchases is as follows.
Every time a company acquires goods from suppliers, it must record them as purchases in its accounts. The purchase account represents the value of all items obtained from a supplier during a period. Similarly, it includes cash and credit purchases. The purchases account falls under expenses. However, it can also contribute to the inventory account in the balance sheet.
Purchase discounts reduce the amount payable to a supplier in exchange for the goods bought. However, it does not include trade discounts since these concern a reduction in the price of items. Instead, purchase discounts involve lower payments before a specific date. In accounting, these discounts fall under cash discounts.
Sometimes, companies may receive goods from suppliers that are not acceptable. Similarly, these goods may not match the specifications provided to the suppliers. In these cases, customers will return the items to the supplier. This transaction falls under purchase returns. Similarly, it reduces the amount for purchases reportable in the income statement.
Purchase allowances fall between discounts and returns. Usually, it includes events where companies receive defective or damaged goods. However, they do not return these goods to suppliers. They keep the items while the supplier provides a discount in exchange. This discount does not conform to the criteria set for purchase discounts. Nonetheless, they reduce the purchases figure reportable in the income statement.
How to Calculate Net Purchases?
By understanding the components of net purchases, companies can calculate them. The primary item within this equation is the purchases figure. The others reduce this amount to reach the amount of net purchase.
Overall, the formula for net purchases is as below.
Net purchases = Purchases – Purchase discounts – Purchase returns – Purchase allowances
The above net purchases formula considers all the components listed above. However, some companies may not have all these items. In those cases, they can use only the areas that apply to their business. For example, companies can only include purchase returns in the above formula if they don’t get discounts or allowances.
What is the Accounting for Net Purchases?
Net purchases do not have an accounting treatment of their own. Instead, it relies on companies to record each of its components separately. Companies can report the net purchases on the income statement. However, this process occurs through the notes to the financial statements. The net purchases figure becomes a part of the cost of sales calculation.
The accounting for net purchases primarily involves its presentation in the notes. Usually, companies include a calculation for this amount to show how they derive it. This calculation considers the above formula for net purchases. For example, companies can report the following in the notes to the financial statements.
|Less: Purchase discounts||(XXXX)|
|Less: Purchase returns||(XXXX)|
|Less: Purchase allowances||(XXXX)|
In most cases, this presentation concludes the accounting for net purchases. However, companies must derive each of the elements of the net purchases formula. These items come through the accounting records supporting the financial statements. Once companies have the figures for each component, they can calculate the net purchases using the above format.
What are the Journal Entries for Net Purchases?
Net purchases do not involve journal entries for their own. Instead, each element of the net purchase formula requires a separate journal entry. Each of these is available as follows.
The journal entries for purchases include the following.
The journal entries for purchase discounts occur through accounts payable.
The journal entries for purchase returns follow a similar treatment as purchase discounts.
Lastly, purchase allowances also use similar journal entries.
A company, ABC Co., obtains various clothing items from its suppliers. During the accounting year, ABC Co. acquired $250,000 in goods. The company also received cash discounts from its suppliers worth $40,000. Similarly, some of the goods received by ABC Co. were faulty. Therefore, it returned those goods worth $25,000 to the supplier.
Lastly, ABC Co. also received damaged items from one of its suppliers. However, the company decided not to return them in exchange for an allowance. This allowance amounted to $35,000. At the year-end, ABC Co. reported its net purchases in the notes as below.
|Less: Purchase discounts||($40,000)|
|Less: Purchase returns||($25,000)|
|Less: Purchase allowances||($35,000)|
Net purchases report the actual value of goods purchased in the income statement. This figure includes four components. Usually, these include purchases, discounts, returns, and allowances. The accounting for net purchases involves its presentation in the income statement. However, it does not have any journal entries of its own.