Cash Discount on Inventory Purchase

When inventory is purchased from a seller offering cash discount for early payment, the buyer has an opportunity to make payment within a specified number of days called the discount period. If the buyer does so, the seller allows a specified percentage of the price as a discount. Such inventory on which cash discount is offered, can be recorded by the buyer using either of the two methods known as:

Gross Method

The gross method initially records the purchase at gross price. After that, it depends on whether the payment is made within the discount period or after. If the payment is made within the discount period, the buyer will record the payment by debiting accounts payable for the gross price, crediting cash for the difference of gross price and discount received and crediting purchase discounts for the discount received. If discount opportunity is missed, the journal entry is made for the full payment as usual.

Net Method

The net method initially records the purchase at net price (i.e. gross price less the potential discount). If the discount is availed, the journal entry is to debit accounts payable for the net price and credit cash. If the buyer fails to make payment within the discount period, the journal entry is to debit accounts payable for the net price, debit purchase discounts lost for the discount which could be availed and crediting cash for the gross price. It is interesting to note that the purchase discounts lost represents an expense.

The following example provides the journal entries to record inventory purchase using gross method and net method under periodic inventory system.

Example

Company A purchased goods having gross price of $6,000. The supplier offered discount of 8% for payments within 15 days after sale. Pass journal entries to record the purchase using gross method and net method on the following occasions: (a) At the date of purchase (b) On payment within discount period and (c) On payment after discount period

Solution:

Gross Method Journal Entries

(a) On the date of purchase

Purchases6,000
Accounts Payable6,000

(b) For payment with in discount period

Accounts Payable6,000
Cash5,520
Purchase Discounts480

(c) For payment after discount period

Accounts Payable6,000
Cash6,000

Net Method Journal Entries

(a) On the date of purchase

Purchases5,520
Accounts Payable5,520

(b) For payment with in discount period

Accounts Payable5,520
Cash5,520

(c) For payment after discount period

Accounts Payable5,520
Purchase Discounts Lost480
Cash6,000

Written by Irfanullah Jan