Why can a retailer record its purchase of merchandise as a debit to purchases within the cost of goods sold, instead of the asset inventory?
Before we explain why companies will record the purchases of merchandise in the Purchases account instead of the Inventory account, let's agree that the objective of the accounting process is to have accurate financial statements. In this case we want an income statement which reports an accurate amount of cost of goods sold, and the resulting gross profit and net income. We need the balance sheet to report an accurate cost of inventory, and the resulting amount of current assets, working capital, total assets, and stockholders' equity. I believe this objective will require some type of an adjustment to the the Inventory account balance and to the cost of goods sold regardless of how the purchases of merchandise were initially recorded.
Now for the reason companies often record purchases in a purchases account. Generally, companies will have a relatively stable amount of inventory and the cost of its annual purchases will be many times the cost of its inventory. This means that most of the cost of its purchases will appear as the cost of goods sold on its income statement. For the minor change in the cost of inventory from the beginning to the end of the accounting period, an adjustment can be made. For example, let's assume that the cost of purchases during the year amounted to $560,000. Let's also assume that the inventory at the end of the year has a cost of $70,000 compared to the inventory cost of $67,000 at the end of the previous accounting year. An adjustment will be entered to debit the Inventory account for $3,000 which will increase the Inventory account balance from $67,000 to $70,000. The credit portion of the entry of $3,000 will cause the cost of goods sold to be reported as $557,000 ($560,000 of debits in the Purchases account during the year minus the amount that increased the cost of inventory: $3,000). After this adjustment, the balance sheet will report the true cost of the ending inventory of $70,000 and the income statement will report the true cost of goods sold of $557,000.