Periodic Inventory - Purchases: Videos & Practice Problems

In a periodic inventory system, purchases are recorded in a separate purchases account rather than directly in inventory. When goods are returned, the purchase returns account is credited, reducing both inventory and accounts payable. Purchase allowances occur when goods are kept but the price is adjusted due to quality issues, affecting accounts payable and creating a purchase allowances account. Understanding these distinctions is crucial for accurate financial reporting and maintaining the accounting equation.

Periodic Inventory:Purchases

In a periodic inventory system, merchandising companies typically purchase goods in bulk to sell them individually, aiming to profit by buying at a lower price and selling at a higher price. It's important to distinguish between different types of purchases: inventory purchases, which are goods intended for resale, and other purchases like office supplies, which are recorded in a supplies account. Long-term assets, such as copy machines, are categorized separately under machinery or equipment.

In this system, separate accounts are utilized to track inventory purchase transactions, contrasting with a perpetual system where all transactions flow directly through the inventory account. The key accounts in a periodic system include:

• Purchases Account: This account records the total value of goods purchased during the period. When goods are acquired, the purchases account is debited instead of the inventory account. For example, if a company buys 500 units at $5 each, the entry would be a debit of $2,500 to the purchases account and a credit of $2,500 to accounts payable, reflecting the amount owed to suppliers.
• Purchase Returns and Allowances: This account captures the value of goods returned to suppliers or discounts received due to quality issues. Returns reduce the total purchases recorded.
• Purchase Discounts: This account reflects discounts received for prompt payment to suppliers, incentivizing quick payment.

When a company makes a purchase, it debits the purchases account, which increases the total purchases recorded, thereby increasing assets in a broader sense. This method allows for better tracking of inventory purchases without directly affecting the inventory account until the end of the accounting period when a physical count is performed to adjust the inventory balance.

Understanding these distinctions and the flow of transactions in a periodic inventory system is crucial for accurate financial reporting and inventory management.

Periodic Inventory:Purchase Returns

Purchase returns occur when a company returns goods to a supplier for a refund, indicating dissatisfaction with the purchased items. For instance, if a company, TOS, returns 100 units of goods priced at $5 each, the total value of the return amounts to $500. This value is derived from the unit price established in previous transactions.

In accounting for this return, instead of crediting the inventory account, a special account known as the purchase returns account is credited. The process involves debiting accounts payable to reflect the reduction in the amount owed to the supplier. Specifically, the company will debit accounts payable by $500, which corresponds to the value of the 100 returned units, thereby decreasing its liabilities.

Simultaneously, the purchase returns account is credited for the same amount, $500. This account functions as a contra asset account, meaning it reduces the overall value of inventory on the balance sheet. By crediting this account, the company acknowledges that the return of goods decreases its assets by $500.

In summary, the transaction results in a dual effect: it decreases both the company's assets and liabilities by $500. The value of purchases is recorded in a purchase account, while the value of returns is tracked in the purchase returns account. At the end of the accounting period, these figures will be reconciled to provide an accurate financial picture.

Periodic Inventory:Purchase Allowance

In accounting, a purchase allowance occurs when a company retains goods but is dissatisfied with their quality, prompting the supplier to reduce the price. For instance, if a company orders 500 items at $5 each, the initial purchase entry would reflect a total of $25,000, increasing both purchases and accounts payable by this amount. However, if the goods received are of low quality and the supplier agrees to lower the price to $2 per item, the new total for the inventory should be $1,000 (500 items × $2).

To adjust the accounts, the company must decrease the recorded value of the inventory by the difference between the original purchase price and the new price. This difference is $24,000 ($25,000 - $1,000). Consequently, the company will make an entry to reduce the inventory value by $24,000, which involves debiting accounts payable by $24,000 to reflect the reduced liability. The corresponding credit will be made to a purchase allowances account, which serves as a contra inventory account, effectively lowering the net inventory value.

In summary, the initial purchase increases assets through inventory acquisition, while the subsequent adjustment decreases both the inventory value and accounts payable, ensuring that the company only owes the adjusted amount of $1,000. This process highlights the importance of accurately reflecting inventory values and liabilities in financial statements, ultimately impacting the company's balance sheet and cost of goods sold calculations.

Never Satisfied Incorporated (NSI) purchased 400 units of High Quality Goods for $300,000 on account. After inspecting the goods, they decided that 300 units did not meet their standards and NSI received a refund for these goods. If NSI uses a periodic inventory system, the entry to record the return of goods would include:

• A. A credit to Inventory for $225,000
• B. A debit to Accounts Payable for $225,000
• C. A credit to Purchase Discounts for $225,000
• D. A credit to Purchases for $225,000

Answer: (B)

Here’s what students ask on this topic:

What is the difference between a periodic and perpetual inventory system?

In a periodic inventory system, inventory purchases are recorded in a separate purchases account rather than directly in the inventory account. Inventory levels are updated at the end of the accounting period. In contrast, a perpetual inventory system continuously updates inventory records with each purchase and sale, providing real-time inventory levels. The periodic system uses accounts like purchases, purchase returns, and purchase allowances, while the perpetual system directly adjusts the inventory account for these transactions.

How are purchase returns recorded in a periodic inventory system?

In a periodic inventory system, purchase returns are recorded by crediting the purchase returns account and debiting accounts payable. For example, if a company returns goods worth $500, the entry would be a debit to accounts payable for $500 and a credit to the purchase returns account for $500. This reduces both the liability (accounts payable) and the value of the inventory held in the purchase returns account.

What is a purchase allowance in a periodic inventory system?

A purchase allowance occurs when a company keeps goods but receives a price reduction due to quality issues. In a periodic inventory system, this is recorded by debiting accounts payable and crediting the purchase allowances account. For instance, if the original purchase was $2,500 and the allowance is $1,500, the entry would be a debit to accounts payable for $1,500 and a credit to purchase allowances for $1,500. This adjustment reflects the reduced cost of the inventory.

How do purchase discounts work in a periodic inventory system?

Purchase discounts in a periodic inventory system are recorded when a company pays its suppliers quickly and receives a discount. The discount is recorded by debiting accounts payable and crediting the purchase discounts account. For example, if a company receives a $100 discount for early payment, the entry would be a debit to accounts payable for $100 and a credit to purchase discounts for $100. This reduces the overall cost of the inventory.

Why is it important to distinguish between different types of purchases in a periodic inventory system?

Distinguishing between different types of purchases in a periodic inventory system is crucial for accurate financial reporting. Inventory purchases, purchase returns, purchase allowances, and purchase discounts each affect the accounting equation differently. Properly categorizing these transactions ensures that the financial statements reflect the true cost of goods sold and the value of inventory. This distinction helps in reconciling accounts at the end of the period and provides a clear picture of the company's financial health.