Net purchases, in accounting, mean the total amount of purchases made less any discounts received, goods returned, allowances, and tax.
This is the formula:
Net Purchases= Gross Purchases – Purchased Returns – Allowances – Discounts.
In the above equation, the components of the equation have the following meanings:
Gross Purchases:
Gross purchase is the total amount of purchase made by the company before deducting purchase returned, any allowance, and discount either the discount from the trade or cash discount.
Cash purchases require payment in cash at the time of purchase whereas credit purchases require payment at a future date. The purchases account is debited when purchases are made against a credit of cash or trade payables.
A purchase account is used only in a periodic inventory system and not a perpetual inventory system.
Purchase returns:
Purchase returns are the return of the goods the business makes to the seller. This usually happens when the goods have failed to meet a certain business standard or are obsolete or damaged. Purchases are also returned when there is an excess or surplus.
Purchase returns lessen the total purchase amount and have a credit balance. They can either credit the inventory account or their individual purchase returns account. The debit offset is made to the accounts payable account.
Purchase allowances:
Purchase allowances are the deductions in the total amount made when the supplier gives goods at a lesser price due to some defect or fault in the goods.
Purchase discounts:
A business avails a purchase discount if the supplier offers and the buyer avails it within the specific period the supplier has allowed. This is like an early-payment discount.
Another purchase discount is the one the suppliers offer on bulk buying. When a business buys in bulk regularly from a particular supplier, the supplier usually offers them discounts.
The purchase discount also lessens the net purchases and has a credit balance. For example, a supplier is offering a 10% discount on the total amount of goods purchased if the buyer settles the payment within 10 days of buying (the full due date of the payment may be 30 days).
The cost of goods purchased is different from net purchases. Net purchases plus any other charges we pay to acquire the goods we have purchased equal the cost.
Cost of goods purchased= Net purchases + cost of acquiring goods.
Let’s look at this example to understand net purchases a little better.
A business orders an inventory of goods worth USD 200,000 and USD 2,000 of goods came in damaged so they had to be returned and further USD 4,000 goods weren’t up to the business standard.
For the USD 4,000 goods, the business negotiated with the supplier to provide an allowance.
Furthermore, the business must spend USD 20,000 on freight charges to deliver the goods to the warehouse.
The supplier has offered a discount of 20% on the amount of purchase if the business makes the payment within 15 days (full payment is due in 30 days).
This means the business can avail of a discount of USD 30,000 if it makes the payment within 15 days. Let’s suppose they do.
The cost of goods purchased would be 200,000 + 20,000 (freight charges are added as they’re a cost) – 2,000 (returns) – 4,000 (allowances) – 30,000 (discounts)= 184,000.
This is the amount of net purchase + freight charges.
This cost of goods purchased we have calculated is needed when we calculate the cost of goods sold which is a line item on the income statement.
The value of net purchases is reported in the trading section of the income statement. In contrast, the total cost of goods purchased is included in the inventory on the statement of financial position.
Now let’s suppose the business decides not to avail of the discount. The amount of net purchase incurred would be 194,000 and freight charges of USD 20,000. The cost of goods purchased would be USD 214,000.
