The sales account and purchases account should include:

"On account" is an accounting term that denotes partial payment of an amount owed. On account is also used to denote the purchase/sale of goods or services on credit. On account can also be referred to as “on credit.”

Key Takeaways

• "On account" is used in accounting to note partial payments or purchases made on credit.
• Purchases on account are purchases made on credit.
• On account also refers to payment on an account.

How On Account Works

On account can refer to purchases on account, but there are also other ways to use this notation.

Purchases On Account

When a customer or business makes a purchase on credit, a general ledger account known as accounts payable is created or the current one is increased. Accounts payable refers to the short-term debt that a company owes another entity during conducting business operations. As the company purchases more goods on credit, this account will increase. The account will decrease as the company pays off its outstanding bills.

Any purchases made with credit can be referred to as “purchased on account.” A business that owes another entity for goods or services rendered will record the total amount as a credit entry to increase accounts payable. The outstanding balance remains until cash is paid, in full, to the entity owed.

When payment is made against an account, such that the entry in the accounts payable of a company’s books is no longer outstanding, it is referred to as paid on account. Payments made on account decrease accounts payable as a debit entry to the account. Most lenders will accept payments on account.

Example of Purchases On Account

For example, if a business purchases $5,000 worth of merchandise on account, this refers to the purchase of the goods on credit and deferral of payment. The business will have an increase in its accounts payable of $5,000. This means that the business will owe $5,000 for the purchase of the merchandise since they have not rendered payment at the time the goods were delivered.

Types of On Account

On account can refer to several bills or debt settlement events. On account could refer to “payment on account” in which payment is made against a certain customer's account without any reference to a specific invoice.

Payments on account are often made for purchases on account where the customer has not yet received a bill or invoice. They are common in industries in which it is common for businesses to purchase goods and services on credit.

Example of On Account

For example, a customer has a $20,000 outstanding balance due to a vendor. The customer makes a $10,000 payment to the vendor with no reference attributed to an individual invoice. The payment made will be applied against the outstanding balance as a whole. At a later date, the payments can be partially or fully matched to the related invoice. Usually, customers are given a specific period in which to make full payment on a specific invoice, even when credit is extended.

It is very important, for accuracy of accounting, to keep accurate records of all accounts payable and accounts receivable, and to match payments on account with their relevant invoices as soon as can be done so. The maintenance of accurate records and the proper classification of payments allows accounting ledgers to be correctly reconciled at the end of the month, quarter, or year.

The general ledger account Purchases is used to record the purchases of inventory items under the periodic inventory system. Under the periodic system the account Inventory will have no entries until it is adjusted at the end of the accounting year so that it reports the cost of the ending inventory.

Under the periodic system, the cost in the account Purchases will be added to the cost of the beginning inventory to arrive at the cost of goods available. The cost of the ending inventory is computed through a physical count (or an estimate) and is subtracted from the cost of goods available to arrive at the cost of goods sold.

Inventory Account Under the Perpetual Inventory System

The account Purchases is nonexistent with the perpetual inventory system. Under the perpetual inventory system, the cost of inventory items purchased are recorded directly into the account Inventory.

Under the perpetual system, the costs of the goods sold are removed from the account Inventory when the goods are sold and are recorded in the account Cost of Goods Sold. As a result, the balance in the account Inventory should be the cost of the ending inventory.

The purchases account is a general ledger account in which is recorded the inventory purchases of a business. This account is used to calculate the amount of inventory available for sale in a periodic inventory system. 

Under the periodic system, the amount of purchased inventory is compiled throughout a period and added to the beginning inventory to arrive at the amount of inventory available for sale. A physical count at the end of the period establishes the ending inventory valuation, which is subtracted from the amount of inventory available for sale to arrive at the cost of goods sold for the period. Thus, the calculation in which the contents of the purchases account is used is:

(Beginning inventory + Purchases - Ending inventory) = Cost of goods sold

The purchases account is not used in a perpetual inventory system, where inventory purchase and usage transactions immediately update the inventory records, with the intent of maintaining accurate record balances at all times (not just at the end of the reporting period).

As an example of the periodic inventory system, ABC International has a beginning inventory balance of $800,000 and purchases $2,200,000 of inventory during the month. It conducts a physical inventory count at month-end to arrive at an ending inventory balance of $1,100,000. Therefore, the cost of goods sold of ABC for the month is $1,900,000, which is calculated as:

($800,000 Beginning inventory + $2,200,000 Purchases - $1,100,000 Ending inventory)

The amounts recorded in the purchases account may be for raw materials that will require subsequent conversion to be made ready for sale, or they may be for completed merchandise.

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