Net purchases, in accounting, mean the total amount of purchases made less any discounts received, goods returned, and allowances made. This is the formula:
Net Purchases= Purchases – Returns – Allowances – Discounts.
In the above equation, the components of the equation have the following meanings:
Purchases refer to the goods bought with the purpose of selling. Fixed assets a business buys like land, building, machinery, fixture, and fittings aren’t counted in the purchases, as they aren’t bought for the purpose of reselling. Purchases can be categorized into cash purchases and credit purchases.
Cash purchases require payment in cash at the time of purchase whereas credit purchases require payment at a future date in time. The purchases account is debited when purchases are made against a credit of cash or trade payables.
A purchase account is used in a periodic inventory system only and not in the perpetual inventory system.
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 standard of the business 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 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.
A purchase discount is availed by a business if the supplier offers and the buyer avails it within the specific period of time the supplier has allowed it. This is like an early-payment discount.
Another type of 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 amount of 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 (full due date of the payment maybe 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 to the cost of goods purchased. Cost of good purchased= Net purchases + cost of acquiring goods.
Let’s take a look at this example to understand net purchases a little better.
A business orders an inventory of goods worth 200,000. 2,000 goods came in damaged so they had to be returned and further 4,000 goods weren’t up to the standard of the business. For the 4,000 goods, the business negotiated with the supplier to provide an allowance.
Furthermore, the business has to spend 20000 on the freight charges to have the goods delivered 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 a discount of 30000 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) – 2000(returns) – 4000(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 whereas 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 the discount. The amount of net purchase incurred would be 194,000 and freight charges of 20,000. The cost of goods purchased would be 214,000.