Lesson Objectives:- How to purchase using the perpetual inventory system
- Types of purchase transactions
- Recording journal entries for purchases
First let's take a look at what type of transactions are associated with purchases:
Purchases - This is the straightforward transaction of purchasing inventory.
Shipping costs - The seller or purchaser pays a shipping carrier for the item to be delivered.
Purchase return - When inventory is returned for defects, missing pieces or other issues.
Discounts - The company gives customer a discount on the purchase price.
What each of these transactions have in common is that they are all related to the merchandise inventory account. This account will come up in each example we review. Keep in mind that these transactions are only associated with accounts on perpetual inventory systems.
Let's say a company paid for overnight shipping for inventory costing $4,000 with 6 percent tax included. The merchandise inventory would be debited and accounts payable would be credited.
When you get into more intermediate and advanced accounting courses, you will find that the taxes are recorded as a separate transaction but we will keep it simple for the purpose of introducing you to the concept.
After the journal entry for the merchandise is recorded, we must record the shipping costs. The two types of payment methods for shipping include FOB shipping and FOB destination. The acronym FOB stands for free on board.
When the purchaser pays for the shipping costs, it is considered FOB shipping terms. In contrast, when the seller pays for shipping, it is FOB destination.
The best way to remember these terms is that when the seller pays for shipping costs, they are trying to get the merchandise to the destination. Normally when a customer purchases merchandise, they specify in their purchase order or terms and conditions document which type of shipping they are wanting to use.
Let's say the shipping costs for a shipment of goods is $80. For FOB shipping, the $80 would be recorded as a debit to merchandise inventory and a credit to accounts payable. If FOB destination is used, there would be no journal entry for the transaction because the seller is capitalizing the cost of the inventory.
Now let's review the journal entry for purchase returns, when the company is returning inventory to the seller.
This is one of the easiest transaction types to journalize as it is the reverse of a purchase entry. Instead of debiting the merchandise inventory and crediting the accounts payable, a return is recorded by debiting the accounts payable and crediting merchandise inventory.
Finally, the last type of purchase entry is discounts which are broken down into two types: quantity discounts and purchase discounts.
- Quantity discounts are given for purchasing inventory in bulk. Normally, a percentage discount is offered when the company purchases a certain amount of the product.
- Purchase discounts come up more frequently and account for when payment is paid early in cash. An example would be when the seller offers a 3 percent discount, if the full balance is paid within 10 days. This type of discount is often written in the following form: 3/10 n/30, where the n/30 stands for the standard net 30 days, which would be the full price.
For example, a discount of $40 was offered on the inventory purchase that had a full price of $4,000. First, the purchase entry would be recorded as a debit of merchandise inventory and credit of accounts payable. To show the discount, the accounts payable would be debited by 4,000 and cash credited for $3,960. You can't leave the entry unbalanced, so the merchandise inventory would need to be credited for $40.
We've covered the four types of purchasing transactions and examples of how they are recorded as journal entries. In the next lesson, we will talk about journal entries for different types of sales.