What should be the entry when goods are purchased at a discount?

Merchandise Inventory decreases to align with the Cost Principle, reporting the value of the merchandise at the reduced cost. This is mainly an incentive to the purchasing party to settle the bill earlier than the prescribed what is work in process inventory date. And the “2/10 N/30” on the invoice means that the due date for the credit purchase is 30 days. However, if the customers pay within 10 days, they will receive a 2% discount on the purchase amount.

This is due to, under the perpetual system, the company records the purchase into the inventory account directly without the purchase account. Hence, it needs to make credit entry to reverse the inventory account when it receives the discount as any amount of the discount will reduce the cost of inventory. There are two methods an entity can use when accounting for discounts. The first is to create a “contra-revenue” account and the second is to simply net the discount immediately off of the Revenue figure. A contra-revenue account is not an account that is shown in the entity’s Financial Statements. It is simply a placeholder account that the entity uses to keep track of their discounts.

Purchase Discount Transaction Journal Entries

Of course, we only pay $9,800 in cash as we receive a cash discount of $200. In the gross method, we record the purchase of merchandise inventory into the purchase account at the original invoice amount. In this section, we illustrate the journal entry for the purchase discounts for both net method vs gross method.

Accounts Payable decreases (debit) for the amount owed, less the return of $1,500 and the allowance of $120 ($8,000 – $1,500 – $120). Since CBS paid on July 15, they made the 15-day window, thus receiving a discount of 5%. Merchandise Inventory-Printers decreases (credit) for the amount of the discount ($6,380 × 5%). Both Accounts Payable decreases (debit) and Merchandise Inventory-Printers decreases (credit) by $1,500 (15 × $100). The purchase was on credit and the return occurred before payment, thus decreasing Accounts Payable. Merchandise Inventory decreases due to the return of the merchandise back to the manufacturer.

In this instance the accounts payable balance is cleared by the cash payment and no purchase discount is recorded. The purchases discounts normal balance is a credit, a reduction in costs for the business. The discount is recorded in a contra expense account which is offset against the appropriate purchases or expense account in the income statement.

The difference in both the accounts is subsequently shown as a trade discount, and the remainder is subsequently credited from the bank (the amount actually paid). If the company does not avail of a trade discount, the subsequent journal entry would be to Debit – Accounts Payable and Credit – Cash/Bank. For example, we are given a 10% discount or $1,000 on the total of $10,000 purchase that we have made. Hence, we need to only pay $9,000 in cash for the purchase upon receiving the goods.

In this journal entry, the purchase discounts is a temporary account which will be cleared to zero at the end of the period. Its normal balance is on the credit side and will be offset with the purchases account when the company calculates cost of goods sold during the accounting period. 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. Later, on January 8, we receive this $200 discount as we make the cash payment for the $10,000 credit purchase.

When preparing the year-end financial statements, the contra-revenue account is netted from the Revenue account, resulting in a Revenue figure net of all discounts. Sample journal entries using discounts can be found in a later post. Merchandise Inventory-Tablet Computers increases (debit) in the amount of $4,020 (67 × $60).

In this method, the amount of purchase recorded is the amount of invoice minus the cash discount. In this method, the discount received is recorded https://www.kelleysbookkeeping.com/the-canadian-employer-s-guide-to-the-t4/ as the reduction in merchandise inventory. Therefore, the amount of discount is recorded on credit to the merchandise inventory account.

Accounting for Purchase Discounts: Net Method vs Gross Method

The purchase discount is based on the purchase price of the goods and is sometimes referred to as a cash discount on purchases, settlement discount, or discount received. For example, on December 31, we have made a $10,000 credit purchase from one of our suppliers and have received the goods on the same day of December 31. There is a “2/10 N/30” term on the purchase invoice which means we will receive a 2% or $200 discount on the $10,000 purchase amount if we make the payment within 10 days. The same as the perpetual inventory system, there is a journal entry needed under the gross method to record the adjustment of discount lost.

We explore how to recognize discounts in different situations, below. Both Merchandise Inventory-Printers increases (debit) and Accounts Payable increases (credit) by $8,000 ($100 × 80). To better illustrate merchandising activities, let’s follow California Business Solutions (CBS), a retailer providing electronic hardware packages to meet small business needs. Each electronics hardware package (see Figure 6.9) contains a desktop computer, tablet computer, landline telephone, and a 4-in-1 desktop printer with a printer, copier, scanner, and fax machine. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping.

Therefore, to set that off, trade discounts are offered which incentivizes buyers of a certain product to pay early, at a cheaper cost. A purchase discount reduces the purchase price of certain inventories, fixed assets supplies, or any goods or products if the buying party can settle the amount in a given time period. The credit terms that are put forth by Blenda Co. mean that Dolphin Inc. is supposed to settle the amount due before 10th January to avail a cash discount of 5%.

1. For example, on December 31, we have made a $10,000 credit purchase from one of our suppliers and have received the goods on the same day of December 31.
2. The purchases discounts normal balance is a credit, a reduction in costs for the business.
3. A purchase discount reduces the purchase price of certain inventories, fixed assets supplies, or any goods or products if the buying party can settle the amount in a given time period.
4. In addition the terms will often allow a purchase discount to be taken if the invoice is settled at an earlier date.

Terms of the purchase are 5/15, n/40, with an invoice date of July 1. On July 6, CBS discovers 15 of the printers are damaged and returns them to the manufacturer for a full refund. Since CBS already paid in full for their purchase, a cash refund of the allowance is issued in the amount of $480 (60 × $8). This increases Cash (debit) and decreases (credit) Merchandise Inventory-Phones because the merchandise is less valuable than before the damage discovery. Since CBS already paid in full for their purchase, a full cash refund is issued. This increases Cash (debit) and decreases (credit) Merchandise Inventory-Phones because the merchandise has been returned to the manufacturer or supplier.

Accounting for Interest Payable: Definition, Journal Entries, Example, and More

On June 1, CBS purchased 300 landline telephones with cash at a cost of $60 each. On June 3, CBS discovers that 25 of the phones are the wrong color and returns the phones to the manufacturer for a full refund. The following entries occur with the purchase and subsequent return. On April 1, CBS purchases 10 electronic hardware packages at a cost of $620 each.

Under Periodic Inventory System

This is because the amount of accounts payable that the company needs to make payment to the supplier under both methods is at the same amount. The cash purchase discounts refer to the discount received when a business settles the payment within the credit term. In this term, it means that the business would receive a cash discount of 2% if the business makes payment within the credit term of 30 days. The journal entry to account for purchase discounts is different between the net method vs the gross method. In the gross method, we record the purchase transaction at the original invoice amount while we record at the net of discount received under the net method. When the company makes the purchase from its suppliers, it may come across the credit term that allows it to receive a discount if it makes cash payment within a certain period after the purchase.