Journal Entry Question:
Purchase with Personal Funds

by Ganesh
(Pune)

Inventory Q: On 25th March 2011 Mr. A purchased goods to the value of rs. 25000 (rs = Rupees = Indian, Pakistani and Sri Lankan currency). Due to a shortage of funds in the business he paid the amount from his personal account. Record the journal entry or entries for this transaction for Mr. A's business.

A: Very good question. The journal entry for the above transaction is:

Debit Purchases 25,000
Credit Capital 25,000

Now for the explanation. In most cases where you see a payment or a receipt of cash the bank account will obviously be affected. But in this case it is not the business bank account. It is paid from his personal bank account. We do not care about the personal bank account, only the business bank account. So we do not have to record anything for bank.

Because we are purchasing goods and this is for the business, we record that it is increasing. Since it is an expense and expenses occur on the left it is debited. The purchases account (expense) is used in a periodic inventory system. A different account (inventory) is used in the perpetual system:

Debit Inventory 25,000
Credit Capital 25,000

In this system we record the goods as an asset (inventory), which occurs or increases on the left side (debit). See the lesson on perpetual and periodic inventory for more details on the two inventory systems.

The credit is to capital, as the owner's share of the business (owner's equity) is increasing. The owner is using his own funds to buy more goods for the business, so he is effectively investing goods into the business. Regardless whether the investment is in the form of assets other than cash - this investment is still an investment and as usual is known as capital.

Hope you do great in your studies!

Best,
Michael Celender