Perpetual Inventory - Purchase Discounts - Online Tutor, Practice Problems & Exam Prep

When a company receives a purchase discount, it can reduce its costs by paying suppliers promptly. For example, terms like 3/10, n/45 indicate a 3% discount if paid within 10 days, with the full amount due in 45 days. If ABC Company buys inventory for $1800 and pays within the discount period, it saves $54, paying only $1746. This transaction affects the accounting equation, increasing inventory and accounts payable initially, then decreasing cash and accounts payable upon payment, ensuring the balance sheet remains balanced.

Perpetual Inventory:Purchase Discounts

Alright, so now let's see what happens when we get a purchase discount, which is a discount for paying quickly to our supplier. You might have seen this already when we talked about sales discounts. If you haven't seen sales discounts yet, I'm sure you will, but you're going to see that it's very similar to this lesson, except now, instead of talking about selling something and offering a discount to our customer, we're the customer getting a discount from our supplier. So let's check it out in this situation. There's a special system used to denote discounts, and let's go through it here. This is how you usually see a discount. You'll see "2/10, net 30". That's how you read that. The "2/10, net 30", the 'n' stands for net, just like you see in the second quote there.

So, let's see what these numbers mean. The numbers are what really matters, and what really matters are those first two numbers. Those are the most important ones. So, the first two there, the "2/10, net 30", the "2", that's the percentage amount of discount that you're going to get. You're going to get a 2% discount if you pay within 10 days. The purchase happened on one day, and now you have the next 10 days to pay and get a 2% discount. The "30" represents the total days you have to pay. So, they told you if you pay within 10 days, you can take a 2% discount, but you have to pay us the full balance by the 30th day. When we solve problems like this, that "30" doesn't really matter, okay? What's really the focus in this class is that percentage discount and whether they qualified for the discount, those first two numbers, the "2" and the number of days that have passed.

Let's check out this example, ABC Company purchased 300 units of Product X for $1800 on January 14, the supplier offered terms of "3/10, net 45". Notice this is different than above; we saw "2/10, net 30", but the principles stay the same. In this case, we're talking about a 3% discount if you pay within 10 days, and then a total of 45 days to pay, but notice that the "45", we're not really going to use it in the problem. So, the supplier offers terms of "3/10, net 45". ABC Company paid the supplier on January 19th. It's really important to think of the dates to see if we qualify for the discount. So, record the purchase and payment in ABC Company's books.

Okay, we're going to have 2 journal entries here, one for the purchase and one for the payment. Obviously, that's what we just said. So let's do the purchase one first. It told us we bought 300 units for $1800 right? The $1800, that's the big number we want, we want dollar values. So, we spent $1800 on inventory, so we're going to debit our inventory for $1800, right? Because that's what we bought, so we're increasing our inventory by $1800, but we haven't paid them yet. We're going to pay them at a future date, right? So, we have an accounts payable, AP for accounts payable of $1800, at some future date, we should have to pay $1800 to them, but what we're going to see is that we get a discount, right? Because in this situation, we purchased it on the 14th and paid on the 19th. That's within our 10-day window, right? On the 15, 16, 17, 18, 19, we paid 5 days later. Cool? So, that's within our 10-day limit to get the discount. So, we're allowed to pay 3% less, right? We get a 3% discount. Let's go ahead and see what that 3% discount is. So, we have $1800 times 3%, $1800 times 0.03 that's $54. $54 is the amount of the discount, so we get to pay that much less instead of paying $1800.

So, let's see how much we do actually pay, $1800 minus the $54 is $1746, okay? So, that is the actual cash that's going to come out of our pocket. We got a discount of $54, but the actual cash is $1746. So, in a perpetual system, we just put all our entries straight up into inventory, okay? So, the first thing we want to do is we want to get rid of the payable, right? It says that we owe $1800 well, we're about to pay that money off, so we're not going to owe the $1800 anymore, we're going to debit accounts payable for $1800 right? We no longer owe that money because we're making the payment. Now how are we paying? We're going to pay with cash and that cash was $1746 like we figured out above, right? So, the last thing is to make this balance, we need that $54 discount. And that discount is just going to go straight to our inventory. We're going to decrease the value of our inventory by the amount of the discount.ởSo, inventory is going to have a credit for $54, alright? And this brings down the value of the inventory to what we actually paid for it, right? We didn't actually pay $1800, we actually paid $1746 and that's what's happening in this question, is bringing down that value to $1746, right? So, in the first entry, our inventory, this one's gonna get a little close here. Our inventory went up by $1800 and our AP went up by $1800. Accounts payable went up by $1800 in the first entry and then what happened in the second entry? Well, our accounts payable went down by $1800. Right? So, that gets rid of that change, and then our cash went down by $1746, and our inventory went down by $54. Okay, so if we were to net this amount of inventory, right it went up by $1800 and then down by $54, that's the $1746 right there, right? So, inventory went up by $1746 and cash went down by $1746, right? So, our assets stayed equal there, our liabilities stay equal and our equation balances, right? So cool, let's go ahead and pause here and then do a practice problem in the next video. You guys can take a stab at this.

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 perpetual system, the journal entry to record the payment on April 25 would include:

• A. A credit to Cash for $14,000
• B. A credit to Inventory for $280
• C. A credit to Accounts Payable for $14,000
• D. A debit to Cash for $13,720

Here’s what students ask on this topic:

What is a purchase discount in perpetual inventory systems?

A purchase discount in perpetual inventory systems is a reduction in the cost of inventory that a buyer can take advantage of by paying the supplier within a specified period. For example, terms like 3/10, n/45 mean the buyer can take a 3% discount if the invoice is paid within 10 days, with the full amount due in 45 days. This discount is recorded directly in the inventory account, reducing the cost of the inventory purchased. This helps companies save money and manage cash flow more effectively.

How do you record a purchase discount in a perpetual inventory system?

To record a purchase discount in a perpetual inventory system, you first record the purchase at full cost. For example, if you buy inventory for $1800 with terms 3/10, n/45, you debit Inventory and credit Accounts Payable for $1800. If you pay within the discount period, you calculate the discount (3% of $1800 = $54). You then debit Accounts Payable for $1800, credit Cash for $1746, and credit Inventory for $54. This reduces the inventory cost to the actual amount paid.

What do the terms 2/10, n/30 mean in purchase discounts?

The terms 2/10, n/30 in purchase discounts mean that the buyer can take a 2% discount on the invoice amount if payment is made within 10 days. The 'n/30' part indicates that the full invoice amount is due within 30 days if the discount is not taken. These terms incentivize early payment, helping suppliers improve cash flow and buyers reduce costs.

How does a purchase discount affect the accounting equation?

A purchase discount affects the accounting equation by reducing the cost of inventory and the amount of cash paid. Initially, when inventory is purchased, Inventory and Accounts Payable increase. Upon payment within the discount period, Accounts Payable is debited for the full amount, Cash is credited for the discounted amount, and Inventory is credited for the discount. This ensures that the total assets and liabilities remain balanced.

Why is it important to pay attention to the discount period in purchase discounts?

Paying attention to the discount period in purchase discounts is important because it allows companies to reduce their costs. By paying within the discount period, companies can take advantage of the discount offered, which directly reduces the cost of inventory. This can lead to significant savings over time and improve the company's cash flow management. Missing the discount period means paying the full invoice amount, which could be a missed opportunity for cost savings.