How would a purchase return be recorded under a perpetual inventory system?
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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. Show 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 entryPeriodic inventory systemUnder 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. AccountDebitCreditAccounts payable/cash000Purchase returns and allowances000The 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 systemUnder the perpetual system, the company can make the purchase return journal entry by debiting accounts payable or cash account and crediting inventory account. AccountDebitCreditAccounts payable/cash000Inventory000In 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. ExampleFor 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.
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: AccountDebitCreditAccounts payable1,500Purchase returns and allowances1,500In 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: AccountDebitCreditAccounts payable1,500Inventory1,500In 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: AccountDebitCreditAccounts payable5,00Purchase returns and allowances5,00Under perpetual system: AccountDebitCreditAccounts payable5,00Inventory5,00In 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. How is a sales return recorded in a perpetual system?When a sales return occurs, perpetual inventory systems require recognition of the inventory's condition. This means a decrease to COGS and an increase to Merchandise Inventory. Under periodic inventory systems, only the sales return is recognized, but not the inventory condition entry.
Is purchases used in perpetual inventory system?In a perpetual inventory system, companies record purchases and sales of inventory as they occur, which means they know the inventory balance and the cost of goods sold at any point in time.
Which accounts are debited in perpetual inventory system?The inventory system where purchases are debited to the inventory account and the inventory account is credited at the time of each sale for the cost of the goods sold. Hence, the balance in the inventory account is constantly or perpetually changing.
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