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 okay; we're still going to go over it right here. So the typical notation for a discount is we're going to see something like this where it says like 2/10 N30 or 2/10 NET30; the N stands for net and these numbers could be any different number. It's just their position that matters. The first number, this 2, that's the percentage amount of the discount. So you're going to get a 2% discount if you pay within the 10-day period. These first two numbers are the most important ones, the 2 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 and our questions because it's not an issue of whether you're ever going to pay or not; 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.

So, when we're in a periodic system, we're going to account for the purchase discounts using this account called purchase discounts. The purchase discounts is a contra inventory account. It's an account that lowers the value of our inventory. Especially in a periodic system, we're going to see at the end when we summarize all the data and put it all together, but these purchase discounts are essentially going to be lowering the value of inventory. So since they're lowering the value of an asset, they go up with a credit. These go up with a credit, but they're a contra asset, right? Specifically for inventory.

Let's see how this works in an example. And just in case you were dealing with perpetual and periodic systems, notice that in a perpetual system everything just goes straight into the inventory account. Here, we have special accounts like the purchase account, purchase returns, purchase allowances, 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 percent discount if you pay within 10 days and you have 45 total days to pay, but notice how that 45 is never going to come up. ABC Company paid the supplier on January 19th. The days and the dates are important so that we can calculate whether we qualify for the discount. We're going to make an entry when we purchase the goods and then another entry when we pay off the goods. So let's start with the purchase entry: we purchased $1800 worth of goods, right? So we're going to 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 going to 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.

Finally, the day comes around that we pay. So we have to figure out, did we qualify for the discount and then if so, how much was it? It was January 14th when we purchased it and we have 10 days. So the 15, 16, 17, 18, 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. 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 going to pay $1800 when we pay our supplier, we're going to pay $54 less. So $1800 minus $54, well that comes out to $1746. That's the actual cash that we're going to pay out. Okay? This is the cash and this is the discount.

So let's go ahead and make that entry. The first thing we want to do is debit accounts payable, right? Because initially, we owe them $1800, and we're finally going to 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 going to have the purchase discounts account and it's going up with this credit here. It's a contra asset account, right, and contra assets, well, they go up with credits. So we've 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. Also, 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.