When we buy products or goods, there is the possibility of a return back to the supplier due to faulty, damaged, or defective within the agreed timeframe. The accounting for purchase return and allowances is straightforward and the recording is different between a perpetual inventory system and a periodic inventory system.
In this article, we cover the accounting for purchase return and allowances; especially the purchase return and allowances journal entry under both periodic and perpetual inventory systems.
So now let’s get started!
What is Purchase Return and Allowances?
Purchase return and allowances refer to the purchase adjustment as a result of the return of goods or merchandise inventory or a reduction from the original purchase price due to damages or defective goods or products. Purchase return and allowances are the contra account of the purchases account in the periodic inventory system. It represents the adjustment to arrive at the net purchases. In the perpetual inventory system, the purchase return and allowances are adjusted directly by reducing the merchandise inventory account.
As mentioned above, in the periodic inventory system, purchase return and allowances is an item presented as a reduction of purchase which is part of the cost of goods sold calculation. It is a contra account of purchases account; therefore, purchase return and allowances are recorded on the credit side.
Classification and Presentation in the Income Statement
As mentioned above, purchase return and allowances is a contra account of purchases account in the periodic inventory system. To arrive at cost of goods sold, we take the purchases or simply purchases minus purchase discount as well as purchase return and allowances and then add up with opening merchandise inventory and transportation-in and finally subtracting the closing merchandise inventory. Below is the extract of cost of goods sold calculation by taking into account the purchase return and allowances under the periodic inventory system:
| Purchases | XXX | |
| Less: Purchase discount | (XXX) | |
| Purchase return and allowances | (XXX) | (XXX) |
| Net Purchases | XXX | |
| Add: Opening merchandise inventory | XXX | |
| Transportation-in | XXX | |
| Less: Closing merchandise inventory | (XXX) | |
| Cost of goods sold | XXX |
Purchase Return and Allowances Journal Entry
Accounting for purchase returns and allowances is simple. In the periodic inventory system, the purchase returns and allowances are recorded into the purchase return and allowances account which is the contra account of the purchases account. Conversely, in the perpetual inventory system, the purchase returns and allowances are recorded as a reduction to the merchandise inventory account directly.
In the section below, we illustrate how the purchase returns and allowances are recorded in both perpetual and periodic inventory systems.
Purchase Return and Allowances Journal Entry under the Periodic Inventory System
Under the periodic inventory system, we simply record it to the purchase returns and allowances account which is the contra purchases account.
Below is the journal entry to record purchase returns and allowances under the periodic inventory system:
| Account Name | Debit | Credit |
|---|---|---|
| Accounts payable | XXX | |
| Purchase returns and allowances | XXX | |
| (To record the purchase returns and allowances to the supplier) |
Purchase Return and Allowances Journal Entry under the Perpetual Inventory System
Under the perpetual inventory system, we record the purchase returns and allowances by reducing them directly to the merchandise inventory account.
Below is the purchase returns and allowances journal entry under the perpetual inventory system:
| Account Name | Debit | Credit |
|---|---|---|
| Accounts payable | XXX | |
| Merchandise inventory | XXX | |
| (To record the purchase returns and allowances to the supplier) |
Example
In order to clearly understand the accounting for purchase returns and allowances, let’s go through the example below.
Let’s assume that ABC Co buys goods to its supplier on 02 January 20X1 for $3,500. In the purchase agreement, ABC Co would be able to return the goods if there is any damage or defect. ABC Co receives goods on the same day. On 05 January 20X1, ABC Co finds out that some of the goods received are defective. Therefore, ABC Co issues a debit memorandum and returns such goods back to its supplier with a value of $100.
From the example above, we illustrate the journal entry for the purchases as well as purchase returns and allowances under both periodic and perpetual inventory systems as follow:
Journal Entry under Periodic Inventory System
The journal entry to record the purchases of goods on 02 January 20X1 is as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Purchases | $3,500 | |
| Accounts payable | $3,500 | |
| (To record the purchases on credit from the supplier) |
The journal entry for the purchase returns and allowances on 05 January 20X1 is as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Accounts payable | $100 | |
| Purchase returns and allowances | $100 | |
| (To record the purchase returns and allowances to the supplier) |
Journal Entry under the Perpetual Inventory System
As mentioned above, under the perpetual inventory system, we record the purchase returns and allowances directly to the merchandise inventory account.
Below is the journal entry to record the purchases on 02 January 20X1:
| Account Name | Debit | Credit |
|---|---|---|
| Merchandise inventory | $3,500 | |
| Accounts payable | $3,500 | |
| (To record the purchases from the supplier) |
On the other hand, below is the journal entry for the purchase returns and allowances under the perpetual inventory system:
| Account Name | Debit | Credit |
|---|---|---|
| Accounts payable | $100 | |
| Merchandise inventory | $100 | |
| (To record the purchase returns and allowances to the supplier) |
As you can see, under the perpetual inventory system the merchandise inventory reduced by $100.
Conclusion
The accounting for purchase returns and allowances is very straightforward. The purchase returns and allowances account under the periodic inventory system is recorded to the purchase returns and allowances account which is the contra purchases account. Unlike the periodic inventory system, the purchase returns and allowances are recorded directly as a reduction of merchandise inventory under the perpetual inventory system.
