The fifth and final article of our series on sales and purchases.
Study Tips: Sales and purchases series
- Sales and purchases 1: Buying and selling
- Sales and purchases 2: Documentation behind buying and selling
- Sales and purchases 3: Difference between cash and credit transactions
- Sales and purchases 4: Sales and purchases in double entry bookkeeping
- Sales and purchases 5: Cash and credit transactions in double entry bookkeeping
This is the last article in the sales and purchases series.
If you have missed the other four then please start at part one and work your way through, as the knowledge and understanding of business basics covered is essential.
We’re going to conclude the series by having a more in-depth look at cash and credit transactions in double entry bookkeeping systems, using the purchases function to illustrate how everything fits together. In part four we discussed the sales function and demonstrated the fact that the only real difference between a cash and credit sale is the length of time it takes for the receipt to end up in the bank. The difference between cash and credit purchases is exactly the same – a cash purchase has to be paid for straight away but paying for credit purchases can be delayed by the length of the pre-agreed payment terms.
Let’s start by being clear about purchases, purchase ledger and the purchase ledger control account (PLCA).
- The goods or services a business buys in order to make the goods or provide the services it sells
- The value of purchases is recorded in the ‘Purchases’ account in the general ledger, that starts each financial year with a nil balance and is increased each time a purchase is entered
- Are a sub-category of expenses. Expenses are day to day running costs, such as utility bills
- Records the value of both cash and credit transactions
- Purchase ledger
- Is the group of individual credit supplier accounts
- Is a subsidiary ledger as it is not part of the double entry process
- Entries into individual supplier accounts are memorandum posting, that are repeats of the actual double entry postings that occur in the PLCA
- Records activity of credit transactions only
- The account that controls and summarises activity in the purchase ledger
- Is a general ledger account and therefore part of the double entry process
- Records all the entries related to the credit purchases process – purchases, purchase returns, discounts received, payments etc.
- Records activity of credit transactions only
Returning to our example of the sale and purchase of stationery for one last time, we’re going to conclude by looking at it from Adam’s point of view. He bought the stationery from Emily so she was his supplier. Adam is a photographer so the stationery is an expense to his business as opposed to a purchase. Therefore, if we look at it as a cash transaction, the entries in Adam’s accounts would be:
However, we know that Emily is one of Adam’s credit suppliers and they have an agreement that allows him 14 days from the date of invoice to pay for the goods he buys. This is a credit transaction and once Adam receives the invoice he needs to record the expense and that he owes Emily £65.32 – the accounts equivalent of an IOU.
The process of recording credit transactions starts with day books. Adam’s purchase day book is below:
Day books are just a list of credit transactions (in this case goods and services purchased) and are not part of the double entry process. However, they are where the double entry postings start. The highlighted figures all need entering into the accounts. The totals at the bottom are entered into the general ledger accounts and are the double entry. The individual invoice totals will be entered into the individual credit supplier accounts in the purchase ledger. They are not double entry posting though, only memorandum entries.
Once posted Adam’s accounts will show:
That was stage one of the credit transaction. Stage two will need to be completed once Adam pays the invoices. Here’s what his accounts look 14 days later:
We’re going to finish by highlighting a couple of useful differences between the accounts.
Behaviour of account balances
We have already said that the ‘Purchases’ account is categorised as an expense and, in part four, that the ‘Sales’ account is income. Both expense and income accounts start the financial year with nil balances which increase through the year, this is because their job is to record the value of the particular expense or income.
Control accounts and individual accounts in both subsidiary ledgers however, have balances that both increase and decrease throughout the year. Their balances continue from one year to the next as opposed to being returned to nil. This is because they are asset/liability accounts and their job is to record all the activity to do with the complete process of credit transactions – stage one when the purchase/sale is recorded and stage two when the payment/receipt is recorded.
Previous study tips will help if you are unsure of account categories and how to increase and decrease them.
VAT-exclusive (Net) amounts and VAT-inclusive (Gross)
Expense and income amounts will always be posted with VAT-exclusive amounts as those are the business’s figures. The VAT is either owed to HMRC or can be reclaimed so it is separated from the business’s figures. However, control accounts and individual accounts in both subsidiary ledgers will, like the bank account, always be posted with VAT-inclusive amounts because that is how much the business will have to pay its suppliers or expects to receive from its customers.
Purpose of accounts
If Adam wants to know how much he currently owes his suppliers then he needs to look at the balance on his PLCA, which shows him £264.36 is outstanding. However, if he has a query from Emily then the PLCA balance is no use to him as it is a summary of all the activity to do with credit purchases. Therefore he’ll need to look at Emily’s individual account in the purchase ledger, which will show him the details of all the transactions that have taken place between them. Finally, if he wants to know how much he’s spent this year on purchases, he’ll need to look at the balance on the ‘Purchases’ account as that will show him the value of his purchases to date, regardless of whether they were paid for on a cash or credit basis.
Gill Myers is a self-employed accounts consultant. She has taught AAT qualifications since 2005 and written numerous articles and e-learning resources.