Purchase Discount Journal Entry
Overview
When the company makes the purchase from its suppliers, it may come across the credit term that allows it to receive a discount if it makes cash payment within a certain period after the purchase. Likewise, this purchase discount is also called cash discount and the company needs to properly make journal entry for it when it receives this discount after making payment.
The credit term usually specifies the amount of discount together with the time period it offers, e.g. “2/10 net 30” or “2/10 n/30”. This “2/10 net 30” means that the credit purchase that the company makes is due within 30 days; but if the company makes payment within 10 days after the invoice date, it will receive a 2% discount on the net amount (gross purchase – purchase returns) of the invoice price.
As there are different types of inventory valuation, the purchase discount journal entry of one company may be different from another. This could be due to one company uses the periodic inventory system while another uses the perpetual inventory system.
Purchase discount journal entry
Periodic inventory system
Under periodic inventory system, the company needs to make the purchase discount journal entry by debiting accounts payable and crediting cash account and purchase discounts.
| Account | Debit | Credit |
|---|---|---|
| Accounts payable | 000 | |
| Cash | 000 | |
| Purchase discounts | 000 |
In this journal entry, the purchase discounts is a temporary account which will be cleared to zero at the end of the period. Its normal balance is on the credit side and will be offset with the purchases account when the company calculates cost of goods sold during the accounting period.
As the company does not record the inventory purchase under the periodic system, whether it receives the discount or not, the journal entry will not involve the inventory account like those in the perpetual system. Hence, there is no inventory account in the above journal entry.
Perpetual inventory system
Under perpetual inventory system, the company can make the purchase discount journal entry by debiting accounts payable and crediting cash account and inventory account.
| Account | Debit | Credit |
|---|---|---|
| Accounts payable | 000 | |
| Cash | 000 | |
| Inventory | 000 |
In this journal entry, there is no purchase discount account like in the periodic inventory system. Likewise, the company simply reduces the cost of inventory in the amount of discount received by crediting the inventory account.
This is due to, under the perpetual system, the company records the purchase into the inventory account directly without the purchase account. Hence, it needs to make credit entry to reverse the inventory account when it receives the discount as any amount of the discount will reduce the cost of inventory.
Example
For example, on October 28, 2020, the company ABC Ltd. receives a discount of 2% on the $3,000 amount due when it makes a cash payment to its supplier on the last day of the discount period.
What is the journal entry of this purchase discount?
- if the company uses the periodic inventory system
- if the company uses the perpetual inventory system
Solution:
Under periodic inventory system
If the company uses the periodic inventory system, it can make the purchase discount journal entry of $60 (3,000 x 2%) on October 28, 2020, as below:
| Account | Debit | Credit |
|---|---|---|
| Accounts payable | 3,000 | |
| Cash | 2,940 | |
| Purchase discounts | 60 |
This purchase discount of $60 will be offset with the purchase account and be cleared to zero at the end of the accounting period.
Under perpetual inventory system
If the company uses the perpetual inventory system instead, it needs to make the journal entry without the purchase discounts account as below:
| Account | Debit | Credit |
|---|---|---|
| Accounts payable | 3,000 | |
| Cash | 2,940 | |
| Inventory | 60 |
Under perpetual inventory system, the company does not have a purchase account nor a purchase discount account. Any transaction related to inventory (e.g. purchase, sale, discount, return, etc.) will be recorded directly into the inventory account. Likewise, the discount above will reduce the cost of inventory by $60, hence, it needs to credit the inventory account by 60 in the journal entry in order to have a fair valuation of inventory under the perpetual inventory system.