Skip to main content
Business LibreTexts

5.4: The Purchase and Payment of Merchandise Inventory (Perpetual)

  • Page ID
    20095
    • girl-160172__340.png
    • Contributed by Henry Dauderis and David Annand
    • Athabasca University
    • Sourced from Lyryx Learning

    learning objective

    LO2 – Analyze and record purchase transactions for a merchandiser.

    As introduced in Chapter 3, a company's operating cycle includes purchases on account or on credit and is highlighted in Figure 5.4.1.

    imga-4.png

    Figure \(\PageIndex{1}\): Purchase and Payment Portion of the Operating Cycle

    Recording the Purchase of Merchandise Inventory (Perpetual)

    When merchandise inventory is purchased, the cost is recorded in a Merchandise Inventory general ledger account. An account payable results when the merchandise inventory is acquired but will not be paid in cash until a later date. For example, recall the vehicle purchased on account by Excel for $3,000. The journal entry and general ledger T-account effects would be as follows.

    General Journal
    Date Account/Explanation F Debit Credit
    Merchandise Inventory 3,000
    Accounts Payable 3,000
    To record the purchase of merchandise inventory on account.

    In addition to the purchase of merchandise inventory, there are other activities that affect the Merchandise Inventory account. For instance, merchandise may occasionally be returned to a supplier or damaged in transit, or discounts may be earned for prompt cash payment. These transactions result in the reduction of amounts due to the supplier and the costs of inventory. The purchase of merchandise inventory may also involve the payment of transportation and handling costs. These are all costs necessary to prepare inventory for sale, and all such costs are included in the Merchandise Inventory account. These costs are discussed in the following sections.

    Purchase Returns and Allowances (Perpetual)

    Assume that the vehicle purchased by Excel turned out to be the wrong colour. The supplier was contacted and agreed to reduce the price by $300 to $2,700. This is an example of a purchase returns and allowances adjustment. The amount of the allowance, or reduction, is recorded as a credit to the Merchandise Inventory account, as follows:

    General Journal
    Date Account/Explanation F Debit Credit
    Accounts Payable 300
    Merchandise Inventory 300
    To record purchase allowance; incorrect colour.

    Note that the cost of the vehicle has been reduced to $2,700 ($3,000 – 300) as has the amount owing to the supplier. Again, the perpetual inventory system records changes in the Merchandise Inventory account each time a relevant transaction occurs.

    Purchase Discounts (Perpetual)

    Purchase discounts affect the purchase price of merchandise if payment is made within a time period specified in the supplier's invoice. For example, if the terms on the $3,000 invoice for one vehicle received by Excel indicates "1/15, n45", this means that the $3,000 must be paid within 45 days ('n' = net). However, if cash payment is made by Excel within 15 days, the purchase price will be reduced by 1%.

    Assuming the amount is paid within 15 days, the supplier's terms entitle Excel to deduct $27 [($3,000 - $300) = $2,700 x 1% = $27]. The payment to the supplier would be recorded as:

    General Journal
    Date Account/Explanation F Debit Credit
    Accounts Payable 2,700
    Merchandise Inventory 27
    Cash 2,673
    To record payment on account within the discount period.

    The cost of the vehicle in Excel's inventory records is now $2,673 ($3,000 – 300 – 27). If payment is made after the discount period, $2,700 of cash is paid and the entry would be:

    General Journal
    Date Account/Explanation F Debit Credit
    Accounts Payable 2,700
    Cash 2,700
    To record payment of account; no purchase discount applied.

    Trade discounts are similar to purchase discounts. A supplier advertises a list price which is the normal selling price of its goods to merchandisers. Trade discounts are given by suppliers to merchandisers that buy a large quantity of goods. For instance, assume a supplier offers a 10% trade discount on purchases of 1,000 units or more where the list price is $1/unit. If Beta Merchandiser Corp. buys 1,000 units on account, the entry in Beta's records would be:

    General Journal
    Date Account/Explanation F Debit Credit
    Merchandise Inventory 900
    Accounts Payable 900
    To record purchase on account; 10% trade discount ($1,000 – 10% = $900).

    Note that the net amount (list price less trade discount) is recorded.

    Transportation

    Costs to transport goods from the supplier to the seller must also be considered when recording the cost of merchandise inventory. The shipping terms on the invoice identify the point at which ownership of the inventory transfers from the supplier to the purchaser. When the terms are FOB shipping point, ownership transfers at the 'shipping point' so the purchaser is responsible for transportation costs. FOB destination indicates that ownership transfers at the 'destination point' so the seller is responsible for transportation costs. FOB is the abbreviation for "free on board."

    Assume that Excel's supplier sells with terms of FOB shipping point indicating that transportation costs are Excel's responsibility. If the cost of shipping is $125 and this amount was paid in cash to the truck driver at time of delivery, the entry would be:

    General Journal
    Date Account/Explanation F Debit Credit
    Merchandise Inventory 125
    Cash 125
    To record shipping costs on inventory purchased.

    The cost of the vehicle in the Excel Merchandise Inventory account is now $2,798 (calculated as $3,000 original cost - $300 allowance - $27 discount + $125 shipping). It is important to note that Excel's transportation costs to deliver goods to customers are recorded as delivery expenses and do not affect the Merchandise Inventory account.

    The next section describes how the sale of merchandise is recorded as well as the related costs of items sold.