How to Record a Purchase Allowance Journal Entry
Learn the proper accounting for a purchase allowance to ensure financial accuracy. This guide covers how to correctly adjust inventory and payables.
A purchase allowance occurs when a buyer receives a price reduction from a seller for goods that are defective, damaged, or otherwise not up to specification. The buyer agrees to keep the merchandise rather than send it back, accepting a lower price as compensation. This differs from a purchase return, where the unsatisfactory goods are physically sent back to the supplier for a full refund or credit. This negotiation results in the buyer retaining the inventory at a reduced cost, which requires a specific accounting entry.
Recording in a Perpetual Inventory System
A perpetual inventory system tracks inventory levels continuously, with every purchase and sale recorded as it happens. When a business secures a purchase allowance, it effectively lowers the cost of the goods it has on hand.
To record the allowance, the business will debit its Accounts Payable account, which reduces the amount of money it owes to the supplier. If the original purchase was made with cash and a partial refund is issued, the Cash account would be debited instead. The corresponding credit is made directly to the Merchandise Inventory account. This credit entry decreases the value of inventory on the balance sheet, ensuring the asset accurately reflects its new, lower cost basis.
Recording in a Periodic Inventory System
Unlike a perpetual system, a periodic inventory system does not update inventory records with each transaction. Instead, inventory is counted and valued at the end of an accounting period. This system uses a separate, temporary account to track these reductions.
When a purchase allowance is granted under this method, the journal entry still involves a debit to Accounts Payable to decrease the liability to the seller. The credit is posted to a specific contra-purchase account called Purchase Returns and Allowances. This account accumulates all allowances and returns throughout the period and is used to calculate the company’s net purchases.
Comprehensive Transaction Example
For example, a company, Retail Corp., purchases $5,000 of merchandise on credit from Wholesale Inc. In any inventory system, the initial purchase is recorded by debiting the inventory-related account and crediting Accounts Payable. This entry increases both the company’s assets and its liabilities.
Upon receiving the shipment, Retail Corp. discovers that some items are slightly damaged. Wholesale Inc. agrees to grant a $400 purchase allowance, and Retail Corp. decides to keep the goods.
Under a perpetual system, the entry is a $400 debit to Accounts Payable and a $400 credit to Merchandise Inventory. In a periodic system, the entry is a $400 debit to Accounts Payable and a $400 credit to the Purchase Returns and Allowances account. The Merchandise Inventory account is not affected at this time; the adjustment is captured when net purchases are calculated at the period’s end.