While the Purchases Accounts are normally classified as temporary expense accounts, they are actually hybrid accounts. The purchase accounts are used along with freight in, and the beginning and ending inventory to determine the cost of goods sold (COGS). All discounts, allowances, https://www.bookstime.com/ and refunds of expenses are reductions in the cost of goods or services purchased and are not income. If they are received in the same accounting period in which the purchases were made or expenses were incurred, they will reduce the purchases or expenses of that period.

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. This https://www.bookstime.com/articles/purchase-discounts is kind of a side account that lets us know that this is what we sold and this is what was brought back. This is why we use a different account that simply reducing sales revenue. These closing entries are a bit more complex than that from the earlier chapter. In particular, note that the closing includes all of the new accounts like purchases, discounts, etc.

Journal Entry

The basic difference between a return and an allowance is that we usually don’t return the goods if they are damaged or unsatisfactory in some way. The vendor issues a Credit Memo anyway and we remove the items from inventory and dispose of them. In the accounting department, you have matched up the receiving documents sent with this invoice and it is now ready to be paid. This means that X Agency will receive a discount of $40 if they make a payment within 10 days, otherwise, they will have to pay the entire $2,000 at the end of the month. On the contrary, the debtor, who has purchased the goods, has a chance to earn more as a result of the amount that is being withheld.

However, purchases are crucial to the operations of these companies. Usually, companies acquire goods for credit and pay for them at a later date. During this process, they may also receive a purchase discount. The net method should be used when discounts are taken on purchases from suppliers. This is because it records the effect of the discount at the time of purchase, rather than later when payment is made.

Practice Question: Purchase Adjustments Under a Periodic System

Let’s assume that the supplier gives companies that purchase a high volume of goods a trade discount of 30%. If a high volume company purchases $40,000 of goods, its cost will be $28,000 ($40,000 X 70%). To comply with the cost principle the company will debit Purchases (or Inventory) for $28,000 and will credit Accounts Payable for $28,000. Remember that the periodic system resulted in a debit to Purchases, not Inventory.

They also paid shipping of some amount that will be posted to a shipping expense account that is not part of COGS. The next illustration contrasts the gross and net methods for the case where the discount is lost. The gross method simply reports the $5,000 gross purchase, without any discount. In contrast, the net method shows purchases of $4,900 and an additional $100 expense pertaining to lost discounts. This is mainly an incentive to the purchasing party to settle the bill earlier than the prescribed date. During this process, they may also process those goods or convert them to another form.