Accounting for Purchase Discounts Entry, Example, and More

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purchase discounts journal entry

Therefore, they can best be described as a contra-purchase account. The incentive to the buyer of purchase discount is that the purchase costs decrease, and the business can save a considerable amount on procurement costs. Record the journal entries for the following purchase transactions of a retailer. On June 8, CBS discovers that 60 more phones from the June 1 purchase are slightly damaged. CBS decides to keep the phones but receives a purchase allowance from the manufacturer of $8 per phone. On 1st January, Dolphin Inc. purchased goods worth $2,000 from Blenda Co.

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.

purchase discounts journal entry

Likewise, this purchase discount is also called cash discount and the company needs to properly make journal entry for it when it receives this discount after making payment. Lastly, at the time of making payment (failing to get the advantage of cash discount), the journal entry to record the payment under both net and gross method are the same. Under periodic inventory system, the company needs to make the purchase discount journal entry by debiting accounts payable and crediting cash account and purchase discounts. We can make the journal entry for the discount received on purchase by debiting the account payable and crediting the purchase discounts account and the cash account. Under perpetual inventory system, the company does not have a purchase account nor a purchase discount account.

Accounting for Purchase Discounts: Net Method vs Gross Method

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.

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.

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.

Summary of Purchase Transaction Journal Entries

Hence, the total accounts payable become a total of $15,000 ($1,470 + $30) the same as the original invoice amount. The net amount is not mentioned earlier on in the analysis because it is still not confirmed if the company will be able to pay the dues in time to be able to avail of the cash discount. Purchase discounts, by nature, are supposed to decrease the purchase costs of the company.

  1. Otherwise, the net amount would be payable in a maximum of 20 days (i.e., 20th January).
  2. The full amount owed to the supplier is shown as a balance sheet liability (accounts payable) and included as purchases or expenses in the income statement.
  3. In this section, we illustrate the journal entry for the purchase discounts for both net method vs gross method.
  4. On the other hand, the seller’s incentive to offer discounts is simply the fact that he is going to receive the total amount much earlier than the requested date.

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 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.

Purchase Discount Transaction Journal Entries

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.

Time Value of Money

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%.

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.

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 cost centres define where costs are incurred 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.

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).

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