Purchase Return Journal Entry
Overview
Purchase return is a transaction where the purchaser is not satisfied and returns goods for some reason, such as goods are defective, damaged, inferior quality, or in wrong specifications, etc. Likewise, the company will need to account for the goods that are returned back to its suppliers with the proper journal entry of purchase return.
Sometimes the company may receive compensation from the suppliers when something is wrong with the goods and it doesn’t have to return the goods. However, the journal entry for it will be with the same accounts as the purchase return.
As there are two methods of inventory accounting including periodic system and perpetual system, when the company returns the purchased goods, the journal entry in the two systems will be different. Hence, two companies that follow different inventory systems will have different journal entries for purchase return.
Purchase return journal entry
Periodic inventory system
Under the periodic system, the company needs to make the purchase return journal entry by debiting accounts payable or cash account and crediting purchase returns and allowances account.
| Account | Debit | Credit |
|---|---|---|
| Accounts payable/cash | 000 | |
| Purchase returns and allowances | 000 |
The purchase returns and allowances is a temporary account which its normal balance is on the credit side. The balances of this account will offset with the purchase account and be cleared to zero when the company closes the account entries at the end of the period.
Likewise, in this journal entry, there is no inventory account involved. This is due to, under the periodic system, the company does not record the inventory either when it makes the inventory purchase journal entry.
Perpetual inventory system
Under the perpetual system, the company can make the purchase return journal entry by debiting accounts payable or cash account and crediting inventory account.
| Account | Debit | Credit |
|---|---|---|
| Accounts payable/cash | 000 | |
| Inventory | 000 |
In this journal entry, the company directly reverses the inventory back in the amount of the returned goods. It doesn’t have to create the purchase returns and allowances account for the returns transaction like those that follow the periodic inventory system.
This is due to, under the perpetual system when the company purchases goods, it does not record in the purchase account (nor does it has the purchase account) but it directly debit the inventory account. Hence, when the goods are returned, the inventory needed to be reduced too.
Example
For example, on October 21, 2020, the company ABC Ltd. returns the goods that it purchased on credit with the amount of $1,500 back to its supplier for the reason of inferior quality.
- what is the purchase return journal entry in ABC’s account on October 21, 2020, for it uses the periodic inventory system?
- if the company ABC Ltd. uses the perpetual inventory system instead, what is the journal entry?
- what is the journal entry if the supplier gives $500 compensation to ABC Ltd. and it does not have to return the goods?
Solution:
1. Periodic inventory system
Under the periodic inventory system, ABC Ltd. can make the journal entry for the purchase return on October 21, 2020, as below:
| Account | Debit | Credit |
|---|---|---|
| Accounts payable | 1,500 | |
| Purchase returns and allowances | 1,500 |
In this case, $1,500 will be offset with the amount of purchase during the period when the company calculates the cost of goods sold.
2. Perpetual inventory system
If ABC Ltd. uses the perpetual inventory system, it can make the journal entry for purchase return on October 21, 2020, as below:
| Account | Debit | Credit |
|---|---|---|
| Accounts payable | 1,500 | |
| Inventory | 1,500 |
In this journal entry, both assets (inventory) and liabilities (accounts payable) are reduced by $1,500 for the purchase return transaction.
3. Compensation is received for not returning goods
If the company does not return the goods but receives compensation for it, the journal entries for both inventory systems are still with the same accounts for the debits and credits as the goods returned.
In this case, as ABC Ltd. does not return goods but it receives $500 as compensation for the inferior quality goods, it can make the journal entry as below:
Under periodic system:
| Account | Debit | Credit |
|---|---|---|
| Accounts payable | 5,00 | |
| Purchase returns and allowances | 5,00 |
Under perpetual system:
| Account | Debit | Credit |
|---|---|---|
| Accounts payable | 5,00 | |
| Inventory | 5,00 |
In the case of the periodic system, the net purchase will be only $1,000 for the goods, so the company needs to make an allowance of $500 to offset the amount of $1,500 at the beginning of the purchase entry. On the other hand, in the case of the perpetual system, the true value of inventory cost is only $1,000, so it needs to reverse $500 back.