Purchases Returns and Allowances

Therefore, companies may return the goods or ask for allowances from their suppliers. Not only must an adjustment to Merchandise Inventory occur at the end of a period, but closure of temporary merchandising accounts to prepare them for the next period is required. Temporary accounts requiring closure are Sales, purchase returns and allowances Sales Discounts, Sales Returns and Allowances, and Cost of Goods Sold. Sales will close with the temporary credit balance accounts to Income Summary. Notice that we did not post the purchases to the inventory account, which is a major difference between this periodic system and the perpetual system.

For some companies, the process may also involve looking for various suppliers and selecting the best option. However, other companies may have a pre-approved list of suppliers from which they purchase goods. Companies incur expenses https://personal-accounting.org/ that are essential in helping generate revenues. Purchases are goods or services obtained or acquired to fund a company’s operations. These differ from other expenses which do not directly contribute to a company’s revenues.

It does not need a cash settlement to become eligible for recording. Since companies already record the purchase expense, they cannot reduce it unless due to an error. Therefore, they need the purchase returns and allowances accounts to offset it. Additionally, periodic reporting and the matching principle necessitate the preparation of adjusting entries. Remember, the matching principle indicates that expenses have to be matched with revenues as long as it is reasonable to do so. Sales returns and allowances is a line item appearing in the income statement.

When you purchase inventory from vendors, there are times when those goods become damaged or cannot be sold as a result of a recall. In these instances, you can return the goods to your suppliers for a refund or credit toward future orders. The purchase returns and allowances journal is a Special Journal used to track these returns and allowances.

1. The first phase of the merchandising cycle occurs when the merchant acquires goods to be stocked for resale to customers.
2. The specific calculation of net purchases will be demonstrated after a few more concepts are introduced.
3. An allowance is a retroactive discount a customer receives when they contact a company about a minor but noticeable defect with its product.
4. We will look at the how the merchandise inventory account changes based on these transactions.
5. You must debit the Sales Returns and Allowances account to show a decrease in revenue.

There are two different techniques for recording the purchase; a periodic system or a perpetual system. Generally, the periodic inventory system is easier to implement but is less robust than the “real-time” tracking available under a perpetual system. Conversely, the perpetual inventory system involves more constant data update and is a far superior business management tool. The following presentation begins with a close examination of the periodic system. Then, the allowance the customer receives is credited to the company’s accounts receivable.

1: Adjusting Entries for a Merchandising Company

If a customer made a cash purchase, decrease the Cash account with a credit. In the accounting general ledger, the credit balances of the contra purchase expense accounts reduce and offset the usual debit balances reported in the standard purchase expense accounts. Purchase Discounts, Returns and Allowances are contra expense accounts that carry a credit balance, which is contrary to the normal debit balance of regular expense accounts. Note that Figure 6.10 considers an environment in which inventory physical counts and matching books records align.

Basic Analysis of Purchase Transaction Journal Entries

As mentioned, these transactions do not impact the purchases account. Nonetheless, it is crucial to understand how a company records the purchase of products or services. Some companies may keep two separate accounts for purchase returns and purchase allowances. However, others may maintain both of them under the same account due to their similar nature.

Example of Purchase Returns and Allowances

This is not always the case given concerns with shrinkage (theft), damages, or obsolete merchandise. In this circumstance, an adjustment is recorded to inventory to account for the differences between the physical count and the amount represented on the books. To illustrate the periodic inventory method journal entries, assume that Hanlon Food Store made two purchases of merchandise from Smith Company. In evaluating the gross and net methods, notice that the Purchase Discounts Lost account (used only with the net method) indicates the total amount of discounts missed during a particular period.

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They also paid shipping of some amount that will be posted to a shipping expense account that is not part of COGS. Both Accounts Payable decreases (debit) and Merchandise Inventory-Printers decreases (credit) by $120 (4 × $30). The purchase was on credit and the allowance occurred before payment, thus decreasing Accounts Payable.

Analyze and Record Transactions for the Sale of Merchandise Using the Perpetual Inventory System

A purchase returns and allowances account is simply a virtual account that exists solely to show the net effect of all transactions relating to returns and allowances. However, they were still usable, so the company decided to keep them. In exchange, the suppliers provided the company with a purchase allowance of $25,000 and a reduction in payable balances. When it returns these goods to the supplier, the accounting entries may differ. Some suppliers may offer exchange products for the returned goods. However, companies do not record this transaction since it results in a net effect of zero.

This allocation must also give consideration to any beginning inventory that was carried over from prior periods. Cash discounts for prompt payment are not usually available on freight charges. For example, if there was a 2% discount on the above purchase, it would amount to $200 ($10,000 X 2%), NOT $208 ($10,400 X 2%).

When we post this adjusting journal entry, you can see the ending inventory balance matches the physical inventory count and cost of good sold has been increased. We learned how the accounting cycle applies to a service company but guess what? We spent the last section discussing the journal entries for sales and purchase transactions. Now we will look how the remaining steps are used in a merchandising company. Those wonderful adjusting entries we learned in previous sections still apply. On July 15, CBS pays their account in full, less purchase returns and allowances.