ACCOUNTING FOR PURCHASES OF GOODS

Description of Account Titles to be used:

1. Purchases This refers to acquisition cost of goods purchased from suppliers.
2. Purchase Discount This refers to prompt payment discount given by suppliers for early
payment of accounts.
3. Purchase Returns This refers to acquisition cost of goods previously purchased but
returned to suppliers due to defects, wrong specifications, and other acceptable reasons.
4. Purchase Allowances This refers to reduction in acquisition cost of goods previously
purchased and discovered with defects but not returned to suppliers.

Norma
Account Accounting l Financial Section
Valuation
Names Element Balanc Statement of FS
e
Purchases Expense Debit Income Cost of Acquisition cost
Statement Sales
Purchase Contra Credit Income Cost of Based on discount
Discount Expense Statement Sales rate approved by
suppliers
Purchase Contra Credit Income Cost of Acquisition cost
Returns Expense Statement Sales
Purchase Contra Credit Income Cost of Based on amount
Allowances Expense Statement Sales approved by
suppliers
Freight - in Adjunct Debit Income Cost of Delivery cost
Expense Statement sales amount, including
other related
costs; also called
inward
transportation or
transportation-in

Notes:
Contra Accounts are accounts deducted from balances of its mother account.

Income Statement Presentation

The Income Statement of a merchandising business is usually presented in multi-step form
because it consists of various steps to compute the net income. It also consists of different
parts as follows:

1. Sales Section
2. Cost of Sales Section
3. Gross Profit From Sales Section
4. Operating Income
5. Operating expenses
6. Net Profit (Net Loss) Section

Cost of Sales Section of the Income Statement:

Merchandise Inventory, beginning of the year XXX
Add: Purchases XXX
Less: Purchase Discount XXX
Purchase Returns XXX
Purchase Allowances XXX XXX
Net Purchases XXX
Add: Freight in XXX XXX
Cost of goods available for sale XXX
Less: Merchandise Inventory, end of the year XXX
Cost of Sales XXX

Recording Purchases Transactions

Acquisition of goods from suppliers can either be on a cash basis or on account basis.

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In recording acquisition of goods from suppliers, expenses of the business increase by the
acquisition cost of such goods being purchased. In contrast, such goods are not yet
expenses upon acquisition because this items are intended for sale which only means that
the buyer will benefit from these goods in the future by selling it. In the end, the benefit is
the PROFIT.

Remember when we say EXPENSES, there is no future benefit at all to be derived from such
item. In short, the company already receives its benefit that is why it is considered as
expense. On the other hand, as long as there is benefit to be received in the future, it is
considered as an ASSET.

In the case of acquisition of goods with the intention to sell, we usually record these goods
based on acquisition cost as an EXPENSE that is why we will use the account name
PURCHASES. It is based on the assumption that these goods will be sold in the future. In
short, it will still become part of expenses.

To simplify the above discussion, upon acquisition of goods or merchandise intended to be

sold in the trading business, the EXPENSE of the company increases. Therefore, the account
name PURCHASES is debited.

To illustrate the two cases of acquisition, see example below:

Case 1: Cash Purchases from ABC Trading, PhP 70,000.00 (Sales Invoice 101).

The accounting journal entry should be:

Purchases 70,000.00
Cash 70,000.00
Cash Purchases (SI No. 101).

Case 2: Purchase merchandise on account basis from XCEL Trading, PhP 50,000.00
(Sales Invoice 105).

The accounting journal entry should be:

Purchases 50,000.00
Accounts Payable XCEL Company 50,000.00
Purchases on account (SI No. 102).

Accounting for Purchase Returns (Basic Problem)

In trading business, returns of goods to suppliers are always possible. This may be due to
major defects discovered for the purchased items that cannot be repaired at all. This may
also be due to wrong specifications. In actual practice, there are other possible reasons for
return of goods purchased to suppliers.

If goods will be returned to suppliers (SELLER), the EXPENSES of the business who bought
(BUYER) such goods will decrease. The amount of the decrease is equivalent to cost of items
to be returned.

To illustrate, see example below:

June 1 - Cash Purchases from ABC Trading, PhP 70,000.00 (Sales Invoice 101).
June 2 - Returned PhP 10,000.00 worth of goods purchased from ABC Trading.

Accounting Journal Entries:

June 1 - Purchases 70,000.00
Cash 70,000.00
Cash Purchases (SI No. 101)

Notes: If the acquired goods were on account basis, the credit should be
Accounts Payable.

June 2 - Cash 10,000.00

Purchase Returns 10,000.00
Return of goods to ABC Trading due to damage.

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 Notes: If the acquired goods was on account basis, the debit should be
Accounts Payable.

Income Statement Presentation:

Merchandise Inventory, beginning of year XXXXXX
Add: Purchases 70,000.00
Less: Purchase Returns 10,000.00
60,000.00
Cost of goods available for sale XXXXXX
Less: Merchandise Inventory, end of year XXXXXX
Cost of Sales XXXXXX

PURCHASE RETURNS as Contra Account (Contra Expense) to Purchases

account.

PhP 60,000.00 is known as NET PURCHASES (Purchases

Purchase Returns)

Accounting for Purchase Allowance (Basic Problem)

In trading business, like Purchase Returns, returns, deduction in acquisition cost is also
possible due to minor defects discovered for the purchased items. This may also be due to
wrong specifications. In actual practice, there are other possible reasons for purchase
allowances.

If goods will be not be returned to suppliers but reduction in cost will be allowed by suppliers
(SELLER), the EXPENSES of the business who bought such goods (BUYER) will decrease. The
amount of decrease is equivalent to approved reduction in price by the authorized personnel
of the Seller.

To illustrate, see example below:

Case 1:
June 1 - Cash Purchases from ABC Trading, PhP 70,000.00 (Sales Invoice 101).
June 2 - Returned PhP 10,000.00 worth of goods purchased from ABC Trading.
June 3 - Purchase allowance of PhP 1,000.00 was granted by ABC Trading due to minor
defects of some items.

Accounting Journal Entries:

June 1 - Purchases 70,000.00
Cash 70,000.00
Cash Purchases (SI No. 101)

Notes:
If the acquired goods was on account basis, the credit should be Accounts
Payable.

June 2 - Cash 10,000.00

Purchase Returns 10,000.00
Return of goods to ABC Trading due to damage.

Notes:
If the acquired goods was on account basis, the debit should be Accounts
Payable.

June 3 - Cash 1,000.00

Purchase Allowances
1,000.00

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 Reduction in cost by ABC Trading due to minor damage.

Notes:
If the acquired goods was on account basis, the debit should be Accounts
Payable.

Income Statement Presentation:

Merchandise Inventory, beginning of year XXXXXX
Add: Purchases 70,000.00
Less: Purchase Returns 10,000.00
Purchase Allowances 1,000.00 11,000.00
59,000.00

Cost of goods available for sale XXXXXX

Less: Merchandise Inventory, end of year XXXXXX
Cost of Sales XXXXXX

PURCHASE ALLOWANCES as Contra Account (Contra Expense) to Purchases

account.

PhP 59,000.00 is known as NET PURCHASES (Purchases Purchase Returns

Purchase Allowances)

Accounting for Purchase Discount (Basic Problem)

In trading business, prompt payment discounts are usually given to customers (BUYERS) by
SELLERS at different rates because the terms may also vary from one transaction to another.
Loyalty of customers is also considered. In accounting, prompt payment discount received
by customers (BUYER) is recorded in the point of voew of the BUYER as PURCHASE
DISCOUNT, and on the point of view of the SELLER as SALES DISCOUNT.
For the meantime, our attention is on the point of view of the BUYER, therefore, the focus is
on PURCHASE DISCOUNT account title.

If Purchase Discounts are received by buyers, his EXPENSES decrease by the amount of the
discount.

Prompt payment discounts are expressed as follows:

(a) 2/10 This means that 2% discount will be given by the SELLER to the BUYER if the
account will be paid within ten (10) days period after acquisition date by the buyer.
(b) 5/10; 2/30 This means that 5% discount will be given by the SELLER to the BUYER
if the account will be paid in full within ten days after acquisition date. Otherwise,
only 2% discount will be given if paid beyond ten (10) days but not later than thirty
(30) days after acquisition date by the buyer.
(c) 2/10; n/30 This means that 2% discount will be given by the SELLER to the BUYER
if the account will be paid in full within ten (10) days period after acquisition date.
Otherwise, discount will not be given to buyer but the account should be paid in full
not later than thirty (30) days after acquisition date.

To Illustrate, let us use the following cases:

Case 1:
On January 1, 2010, Silver Trading purchased merchandise from Bronze Trading amounting
to PhP 200,000.00. Terms: 2/10; n/60.

Situation A: The account was paid within the discount period.

Situation B: The account was paid beyond the discount period.

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Case 2:
On January 1, 2010, Boondock Marketing purchased goods from Mountain Trading amounting
to PhP 100,000.00. Terms: 2/15; 1/30.

Situation A: The account was paid in full within the ten (10) days discount period.
Situation B: The account was paid in full within the thirty (30) days discount period.
Situation C: PhP 40,000.00 was paid within the ten (10) days discount period, the balance
within the thirty (30) days discount period.

ACCOUNTING FOR PURCHASES (COMBINATION OF CASES)

Case 1:
On February 10, 2010, Scorpio Company purchased goods from Gemini Corporation worth
PhP 150,000.00. Terms: 5/20; 2/30.

On February 11, 2010, a reduction of PhP 5,000.00 was given by Gemini Corporation due to
minor defects of some items delivered to Scorpio Corporation.

Situation A: The account was paid in full within the twenty (20) days discount period.
Situation B: The account was paid in full within the thirty (30) days discount period.
Situation C: PhP 50,000.00 was paid within the twenty (20) days discount period, the
balance within the thirty (30) days discount period.

Case 2:
On March 5, 2010, Lucky Company purchased merchandise from Fortune Corporation worth
PhP 250,000.00. Terms: 3/10; 1/60.

On March 6, 2010, PhP 20,000.00 of merchandise was returned to Gemini Corporation due to
major defects of some items delivered.

Situation A: The account was paid in full within the ten (10) days discount period.
Situation B: The account was paid in full within the sixty (60) days discount period.
Situation C: PhP 130,000.00 was paid within the ten (10) days discount period, the balance
within the sixty (60) days discount period.
Case 3:
On February 20, 2010, Single Merchandising purchased goods from Double Corporation
worth PhP 100,000.00. Terms: 20% down payment; balance - 5/20; 2/30.

On February 21, 2010, a reduction of PhP 5,000.00 was given by Single Merchandising due
to minor defects of some items delivered to Double Corporation.

Situation A: The account was paid in full within the twenty (20) days discount period.
Situation B: The account was paid in full within the thirty (30) days discount period.
Situation C: PhP 50,000.00 was paid within the twenty (20) days discount period, the
balance within the thirty (30) days discount period.

Case 4:
On March 15, 2010, Red Ribbon Company purchased merchandise from Black Ribbon
Corporation worth PhP 500,000.00. Terms: 25% down payment; balance - 3/10; 1/60.

On March 16, 2010, PhP 20,000.00 of merchandise was returned to Black Corporation due to
major defects of some items delivered.

Situation A: The account was paid in full within the ten (10) days discount period.
Situation B: The account was paid in full within the sixty (60) days discount period.
Situation C: PhP 200,000.00 was paid within the ten (10) days discount period, the balance
within the sixty (60) days discount period.

Case 5:

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On April 20, 2010, Fatherly Trading purchased goods from Motherly Corporation worth PhP
300,000.00. Terms: 20% down payment; balance - 5/20; 2/30.

On April 21, 2010, a reduction of PhP 10,000.00 was given by Motherly Merchandising due to
minor defects of some items delivered to Fatherly Corporation.

Situation A: The account was paid in full within the twenty (20) days discount period.
Situation B: The account was paid in full within the thirty (30) days discount period.
Situation C: PhP 100,000.00 was paid within the twenty (20) days discount period, PhP
100,000 was also paid within the thirty (30) days discount period, and the balance was paid
balance on the last day of the thirty (30) days discount period.