Financial Accounting

Learn the toughest concepts covered in your Financial Accounting class with step-by-step video tutorials and practice problems.

4. Merchandising Operations

Periodic Inventory - Purchase Discounts

Any discounts we receive for quick payment are also kept in an account separate from our main Inventory account.


Periodic Inventory:Purchase Discounts

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Now let's discuss purchase discounts in a periodic inventory system. So when we talk about discounts in this sense, we're talking about discounts for quick payment. Okay. So we're getting a discount for paying off our debt quickly to our supplier. Okay. So if you might have seen a discussion like this in another video, we talked about this in sales discounts. We talked about this in perpetual inventory, but if this is the first time you're seeing it, that's OK. We're still going to go over it right here. So the typical notation for a discount is we're gonna see something like this where it says like 2 10 and 30 or 2 to 10 net 30. The end stands for net. And these numbers could be any different number. It's just their position that matters. So this first number this too, that's the percentage amount of the discount, so you're gonna get a 2% discount. Okay, If you'll get a 2% discount if you pay within the 10 day period. Okay, So these first two numbers are the most important ones. The two and the 10 are the most important numbers in this situation. The other number, the 30 in this case. Well, that's the total days you're allowed to pay. This number doesn't really come up in our solutions in our questions because it's not an issue of whether you're ever going to pay or not. Okay, the main, the main issue when we discuss this is whether or not you qualify for the discount, are you within that 10 day period, 15 day period, whatever they give you and then calculating the discount based on the percentage. Okay So when we're in a periodic system we're gonna account for the purchase discounts you're using. This this account called purchase discounts. Okay. The purchase discounts is a contra inventory account. It's a it's a account that lowers the value of our inventory. Especially in a periodic system. We're gonna see at the end when we summarize all the data and put it all together that these purchase discounts are essentially gonna be lowering the value of inventory. Okay? So since they're lowering the value of an asset they go up with the credit. Okay these go up with the credit but they're in there a contra asset. Right? Specifically for inventory. Alright So let's see how this works in an example. And just in case you you were dealing with perpetual and periodic system notice that in a perpetual system everything just goes straight into the inventory account here we have these special accounts like the purchase account, purchase returns, purchase allowances. Right? And now purchase discounts. Another special account here. So in our example abc company purchases 300 units of product X. For $1800 on january 14th. That's important. The supplier offered terms of 3 10 net 45. So there we go 3 10 net 45 a 3% discount if you pay within 10 days and you have 45 total days to pay. But notice how that 45 is never gonna come up. ACC Company paid the supplier on January 19. The days the dates are important so that we can calculate whether we qualify for the discount. Alright so we're gonna make an entry when we purchase the goods and then another entry when we pay off the goods. Okay so let's start with the purchase entry And the purchase entry. Well we purchased $1800 worth of goods. Right? So we're gonna have our purchases account in a periodic system for 1800 and that's a debit right? That's increasing like an asset value and we're gonna have a credit to accounts payable right definitely in this problem we haven't paid them yet because we might get the discount when we pay. So finally the day comes around that we pay so we had to figure out one did we qualify for the discount? And then if so how much was it? So let's first see if we qualify. It was january 14th when we purchased it and we have 10 days. So the 15 16 17, 18 19th when we paid, that's within our 10 day period. Right? So we did qualify for the discount, let's see how much that discount is. So the 1800 times 3% 3% is going to be the discount, right? The 3 10 net 30. So 1800 times 3% give me one second to pull up the calculator, $54 $54 is the discount in this case. Right? So we're not gonna pay $1,800 when we pay our supply. We're gonna pay $54 less. So 1800 -50 for well that comes out to 17 1746. That's the actual cash that we're going to pay out. Okay, so this is the cash and this is the discount. Alright, so let's go ahead and make that entry. The first thing we wanna do is debit accounts payable, right? Because initially we owed them $1,800 and we're finally gonna pay them now, right, we're making that payment so we don't owe that money anymore. So we're going to debit the accounts payable for the full 1800. There's no more Money owed. Now, how did we get rid of that accounts payable? Well, we paid cash of 1746. Right? And then we got the discount. Right? And we're gonna have the purchase discounts account and it's going up with this credit here, right? It's a contra revenue account. And excuse me, contra asset account. Right? And contra assets. Well, they go up with credits there. Alright. So we made our entries. Let's look at what happened the purchases. Those are purchases of our inventory. Those are assets. So we've got 1800 here. That was an increase to our assets. And then our cash went down By 1746. And also I'm gonna do it underneath here. Yeah, I'll do it underneath purchase discounts. Those were 54 and that's also lowering the value of our inventory. Right those discounts because we didn't end up paying 1800, we paid a little less so the inventory is worth that much less. And what about on our liability side we had the accounts payable go up by 1800 when we made the purchase And then they go down when we actually pay it off. So that washes out and notice that everything balances out here. The purchases of 800. Well they wash out with the cash and the purchase discount and the ap washes out as well so we are balanced. Cool. Let's pause here and then do a practice problem in the next video.

On April 12, a company purchased goods worth $14,000 on account with terms of 2/15 net 30. The company paid its supplier on April 25. In a periodic system, the journal entry to record the payment on April 25 would include: