April 2023

Under perpetual inventory system, the company does not have a purchase account nor a purchase discount account. Any transaction related to inventory (e.g. purchase, sale, discount, return, etc.) will be recorded directly into the inventory account. Some suppliers offer discounts of 1% or 2% from the sales invoice amount, if the invoice is paid in double declining balance depreciation method 10 days instead of the usual 30 days. How Do Purchase Discounts Differ From Trade Discounts? However, the discount received is the concession in the price received by the buyer of the goods and services from the seller and is an income for the buyer. For example, in the terms “3/10 net 45,” a company can receive a 3% discount if it pays within 10 days, while the total payment is due within 45 days. Understanding these terms is crucial for managing cash flow effectively. 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. A business purchases inventory worth $3,000 and is offered a 4% cash discount for early payment. The following are examples of contra expense accounts used in double entry bookkeeping. What is Discount Received? Accounts Payable decreases (debit) and Cash decreases (credit) for $4,020. The company paid on their account outside of the discount window but within the total allotted timeframe for payment. CBS does not receive a discount in this case but does pay in full and on time. How do you record a purchase discount in a perpetual inventory system? For example, if a company buys \$1800 worth of goods and qualifies for a \$54 discount by paying early, the inventory’s value is reduced by \$54. This is recorded by crediting the purchase discounts account, which offsets the inventory’s value, ensuring accurate financial reporting. When accounting for purchase discounts in a periodic inventory system, a specific account called “purchase discounts” is used. This account is classified as a contra asset account, meaning it reduces the overall value of inventory. Double Entry Bookkeeping This information directly affects a company’s gross and operating profit. A purchase discount is a small percentage discount a company offers to a buyer to induce early payment of goods sold on account. The journal entry to account for purchase discounts is different between the is purchase discount a debit or credit 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. In this journal entry, there is no purchase discount account like in the periodic inventory system. Likewise, the company simply reduces the cost of inventory in the amount of discount received by crediting the inventory account. Benefits of Offering Discounts Allowed Discounts allowed refer to reductions in the invoice price given by how is sales tax calculated a seller to customers. These discounts encourage prompt payment and build customer loyalty. Discounts allowed are recorded as an expense in the seller’s books. However, in the net method, we record the purchase transaction at the net amount assuming that the payment would be made exactly on or before the agreed credit term. On April 1, CBS purchases 10 electronic hardware packages at a cost of $620 each. An invoice for the full amount is received by the buyer, which includes the offer for a discount. This could be in the form of additional discounts, extended credit terms, and priority service. All of which will benefit the business by reducing costs and improving supply reliability. Trade discount is the type of discount that we may receive upon the purchase. This discount is usually given when we purchase a large volume of goods or products from our suppliers. Receiving Payment from Customers On October 15, the customer pays their account in full, less sales returns and allowances. Also a general ledger account in which the purchase discounts are recorded under the periodicinventory method. However, if the retailer fails to pay the invoice within the early payment discount period, the retailer is required to remit $1,000. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University. In a periodic inventory system, purchase discounts are offered for early payment, typically noted as 2/10, n/30, where 2% is the discount if paid within 10 days. The 10% discount is a trade discount and should therefore not appear in Bike LTD’s accounting records. In 2006, she obtained her MS in Accounting and Taxation and was diagnosed with Hodgkin’s Lymphoma two months later. Purchase Discounts is also a general ledger account used by a company purchasing inventory goods and accounting for them under the periodic inventory system. A reduction to Accounts Receivable occurs because the customer has yet to pay their account on October 10. On September 8, the customer discovers that 20 more phones from the September 1 purchase are slightly damaged. The customer decides to keep the phones but receives a sales allowance from CBS of $10 per phone. Accounts Payable decreases (debit) and Purchase Returns and Allowances increases (credit) by $120 (4 × $30). The purchase was on credit and the allowance occurred before payment. Accounts Payable decreases (debit) and Purchase Returns and Allowances increases (credit) by $1,500 (15 × $100). Discount Allowed and Discount Received Go back through the transactions to see if the company is the buyer or seller. Read the transactions carefully or you may lose a lot of points on a problem you know how to do. Most businesses do not offer early payment discounts, so there is no need to create an allowance for sales discounts. By doing so, you can immediately reduce sales by the amount of estimated discounts taken, thereby complying with the matching principle. A company may choose to simply present its net sales in its income statement, rather than breaking out the gross