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Journal Entries – Paying on credit

Imagine the following scenario:

Scenario: On March 7th, you realize that you need some more base-model hats. You purchase 10 hats for $75 on credit, promising that you'll pay the vendor back soon.

In this situation, we're not paying with cash, we're paying on credit. We'll get to what that means in a second... for now let's go phrase-by-phrase and build up this journal entry!

Phrase-by-phrase

Scenario: On March 7th, you realize that you need some more base-model hats. You purchase 10 hats for $75 on credit, promising that you'll pay the vendor back soon.

What this tells me here is that we're increasing our Inventory, since these hats will be used as the end-product for customers soon. (We're NOT increasing Supplies here! These hats aren't for daily operations of the business!)

Inventory is an asset, therefore increasing it means that we'll debit it! (Remember: assets have a normal debit balance!)

That'll look like so in our journal entry:

TransactionDebitCredit
Inventory???
     ??????

What's the value of this Inventory that we added? According to the phrase, it's $75!

TransactionDebitCredit
Inventory$75
     ??????
TransactionDebitCredit
Inventory$75
     ??????

Scenario: On March 7th, you realize that you need some more base-model hats. You purchase 10 hats for $75 on credit, promising that you'll pay the vendor back soon.

In the past for purchases, we've credited the Cash account. However, in this case, we're not paying with cash. We're paying "on credit"... which means we'll use the Accounts Payable account!

Use the Accounts Payable account whenever you purchase something on credit, or promise to pay the vendor back later.

Accounts Payable is a liability account. When we make a payment "on credit", we're increasing our liability, since that amount is something that we owe back to the vendor at a later date.

Therefore, since we're increasing a liability account (Accounts Payable), that means we're going to credit it, since liabilities have a normal credit balance!

TransactionDebitCredit
Inventory$75
     Accounts Payable???

By how much should we credit Accounts Payable?

Well, according to the previous phrase, the hats were worth $75 in Inventory. Therefore, we'll need to pay $75 back to the vendor at a later date (through Accounts Payable)!

TransactionDebitCredit
Inventory$75
     Accounts Payable$75

...and means that we have $75 that we'll need to pay back to the vendor at a later date (Accounts Payable).

TransactionDebitCredit
Inventory$75
     Accounts Payable$75