Periodic Inventory - Purchases - Online Tutor, Practice Problems & Exam Prep

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

Alright, so now let's go into a little more detail about purchasing inventory in a periodic inventory system. What we're going to see is that a merchandising company, just like we've been talking about, generally buys goods in bulk and sells them to customers individually. Right? That's where they make their money is by buying a little cheaper and then splitting it up and selling it to customers. One thing I want to note real quick before we continue is that I've made the same, pretty much almost exactly the same lessons for a perpetual system. Right? Most books focus solely on the perpetual system, some books solely on the periodic, and some books focus on both. Right? So if you have both, it's really nice to have both lessons and you can compare and contrast all of these topics between the two systems. Alright? And if you only have a perpetual system in your book or your teacher is only focusing on perpetual, again, I don't know why you're here right now. But let's go ahead and learn about periodic purchases.

So one thing I want to note real quick is that companies purchase all sorts of things; we don't just purchase inventory. Inventory is the thing that we're going to resell. When we purchase goods for resale, that goes into our inventory account, right? That is an inventory purchase. But what about when we buy pens, papers, staplers, office supplies like that? That goes into our supplies account, right? So you want to make a distinction of where you're putting your purchases. The only thing that goes in inventory is things that we buy to resell. Okay?

The last thing is a copy machine. So a copy machine, yeah, this is a long-term asset, right? This might go into machinery, equipment, something like that, right? Something a long-term asset, that's going to last us a few years. So notice our focus in this section is on these goods acquired for resale, going into inventory, right? We're focusing on the inventory account. So let's go ahead and continue here.

In a periodic system, we use separate accounts to account for inventory purchase transactions. This is different from a perpetual system. Okay? A perpetual system, everything just flows through inventory. Here we're going to have special accounts for purchases, purchase returns and allowances, and purchase discounts. Okay, so let's go into these in a little detail.

The purchases, well this is the value of all goods purchased during the period. Notice that it doesn't go straight to inventory. We're not debiting inventory for these purchases; we're debiting a purchases account. Next one, purchase returns and allowances. So this is the value of purchases that are returned. So if we bought something and then returned it to the supplier or discounted it because of a quality issue. Okay. A key thing about the allowances: the allowances are discounts for some issue with the quality, some unhappiness you have with the product when it arrives compared with the purchase discount, notice the purchase discount is the value of discounts received for quick payment. So when we pay our suppliers quickly, they might offer us a discount for that quick payment. Okay?

So let's go ahead and start here with a purchase. When the company purchases goods, we debit the purchases account. Notice in this situation, we are debiting the purchases account, not the inventory account. So, things on shelves, the company purchased 500 units of things on account at a price of $5 per thing. Well, that's 500 things times $5; they purchased $2,500 worth of things, right? So in a perpetual system, this would go straight to our inventory, but here we're going to debit purchases, this is our debit entry right here for $2,500, and we're going to credit, well, it says on account, right? We didn't pay them in cash so we're going to credit accounts payable (AP) for $2,500.

Accounts payable, that's money that we owe and we owe it to our suppliers. So in this case, what exactly has happened? This is pretty simple, right? We see that our purchases went up. Purchases is a type of inventory account, so it does in essence increase our assets, right? We're just holding this inventory value somewhere else just so we keep track of all our purchases. Cool? Cool? Alright, so our balance equation stays balanced. Let's go ahead and pause here. In the next video, we'll continue with purchase returns, purchase allowances, we'll figure out the rest of this stuff. Alright? Let's keep going.

Periodic Inventory:Purchase Returns

Alright, so let's continue here with purchase returns. So this is when the company returns goods for a refund, right? They're not happy; they just want their money back; they're returning for a refund, a purchase return. So TOS company returned 100 units of things to its suppliers. Up above, we said those things were at $5 apiece. So how much are they returning? 100 things at $5 apiece, They're returning $500 worth. Okay? That $5 value came from our previous example where they told us at a price of $5 per thing up there. Okay? So the company returns goods. We're talking about a purchase return. So they returned $500 worth of goods.

In this case, what we're going to do instead of crediting our inventory account, we're going to credit a special account for the purchase returns. So the debit in this situation, right? We first of all, in the first question, we had bought 500 things, right? So we owed money for 500 things, but now we're returning 100 so we're going to owe less money, right? So we need to debit our accounts payable to lower the value of accounts payable by this $500 value of the 100 things. So the 100 things having a $5 value each, we're going to lower the amount that we have to pay by $500 and we're going to credit the purchase returns account. Notice that this is a credit account: purchase returns for $500.

So there's a debit to accounts payable for $500 to lower the amount we owe because we return something and then we're going to hold all the value of all our returns in this purchase returns account for $500. Cool? Alright. So what happened in this question? Well, the purchase returns, this is a contra asset. This is a contra inventory account, right? Because it lowers the value of inventory. Assets and this $500 value is actually decreasing the value of our assets by $500. This is a credit to an asset account, So that's decreasing values of assets. Okay?

So the purchase returns is decreasing our assets, but we're also decreasing our liabilities by $500. Right? So there we go. We're notice what we're doing at this point. We're storing value. We've stored the value of our purchases in a purchase account. We've stored the value of purchase returns in a purchase returns account. And then at the end of the period, remember this is the periodic system, we're going to reconcile all these numbers. Alright? So let's go ahead and pause here and then continue in the next video.

Periodic Inventory:Purchase Allowance

Alright, so let's continue here with the purchase allowance. So, this is when a company keeps the goods, but they're unsatisfied, so the supplier lowers the price. There's some sort of quality issue; they want a discount on the goods that they're going to keep. Okay? So TOS ordered 500 things on account at $5 per thing. When low-quality things arrived, the supplier agreed to lower the price to $2 per thing, okay?

Notice we had an original entry, we would have made some sort of entry like purchases purchases, well, it was 500 things times $5 a thing, $2,500. Right? So we would have increased our purchases by $2,500 and our accounts payable. Right? We're going to eventually have to pay for these things at $2,500, but then we inspected the things and we weren't so happy with them. Right? They were low quality and the supplier agreed to charge only $2 per thing. So 500 things, well, that's $1,000, right? So $1,000 is what our inventory should actually be. We purchased $2,500, well, we need to lower that value by the difference, right? To get it down to $1,000. So $2,500 minus $1,000, this $1,500 is the amount we need to lower the value of our inventory because we're only paying $2 per thing. So we would make some sort of entry to lower the value of our inventory.

The other part of the entry is the accounts payable, right? We're no longer going to owe $5 per thing to them, we only owe $2 per thing, so we only owe them $1,000. So we also need to decrease our accounts payable by that same $1,500. So we're going to have a debit to accounts payable. So I'll do a debit to accounts payable for $1,500. Right? This debit of $1,500 brings the balance down to $1,000 and we're going to credit purchase allowances for $1,500, okay? Notice this doesn't go straight to the inventory account; again, we're storing the value of these allowances and then at the end of the period, we're going to net all these things together to figure out the inventory and the cost of goods sold. Cool?

Alright. So let's see what happened here. The purchases well, those purchases are going to increase the value of our assets. Right? We bought inventory and then our AP. We owed money of $2,500, but then in the second entry, the AP went down, right? Down to the $1,000 that we actually owe, so it went down by $1,500, and our purchase allowance is going to lower the value of our assets because it is a contra inventory account that lowers the value of inventory of our net inventory at the end. Okay. So it's going to be decreasing our assets there and you'll see that the assets went up by a net of $1,000 and so did the liabilities, so we are good here.

Alright, let's go ahead and pause here and then do a practice problem.

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

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.