When using the periodic method, the entries for allowances are the same as entries for returns because we do not track inventory under the periodic method. Whistling Flutes has the same amount of value in inventory that it had before the transaction. Did the seller’s cost of inventory change? Does the seller have more or less value in the Inventory account because of the allowance? There is no change to the Inventory account. What about the seller’s entry? We know the amount of the sale has changed along with the amount owed on the receivable. In both cases the dollar value of the inventory has changed, so the entry is the same. We are not tracking physical quantities of inventory here. Notice the entries for returns and allowances are the same for the buyer. Even though the quantity of inventory is the same, the cost has changed. Therefore, we must record the decrease in the cost of the inventory. Did the cost of the inventory purchased by Medici change? Yes, the cost is now $200 lower than it was previously recorded because of the allowance provided by Whistling Flutes. Under the perpetual method, we must always track changes to the cost of inventory. Whistling Flutes agreed to discount the flutes by $200 and Medici agreed to keep the flutes. On August 16, Medici Music discovers that two of the flutes it ordered from Whistling Flutes, LLC were slightly scratched. When dealing with allowances, it is important to note if the value of the inventory is changing on each side of the transaction and record that change correctly depending on the inventory method being used.

Maybe it was the wrong color or maybe there is slight damage to the product but it can still be sold at a discount. Sometimes this happens because the inventory is incorrect but the buyer thinks it can still be sold. The buyer gets to keep the merchandise but receives a discount on the merchandise. In the case of an allowance, the physical inventory is not returned to the seller. What Is an Allowance?Īn allowance is similar to a return in the fact that the seller is giving the buyer a credit on the account because something is wrong with the order.

Under period inventory, we do not record changes in inventory until the end of the period, so this entry is fairly simple. This entry is very similar to the entry used under perpetual inventory, but instead of Inventory we use Purchase Returns and Allowances. So let’s look at the entry for the same transaction under periodic inventory. Can you guess? Purchase Returns and Allowances! Really tricky, huh? Most of the time in accounting, the account names describe what is going on. Since we are now discussing returns and allowances, can you figure out what account we will use? It’s really tricky. When we discussed discounts, we used Purchase Discounts. Instead, we use Purchases and the contra accounts related to Purchases. Under periodic inventory, we do not use the Inventory account to record day-to-day transactions. Since we are tracking the returns through Sales Returns and Allowances, there is no need to create a contra account for Cost of Goods Sold. We just reduce the amount in Cost of Goods Sold. Notice there is no contra account for Cost of Goods Sold. The value being returned to inventory is the cost that Whistling Flute paid for the inventory, which is $400. Because we want to preserve the original sales data and track returns, we are going to use a contra account called Sales Returns and Allowances to record the revenue portion of the transaction. As the seller, Whistling Flute needs to show not only the return of the inventory but also the reduction in sales. Now, let’s look at the entry from Whistling Flute’s perspective. Medici also owes less money to Whistling Flutes because the merchandise is returned.Įssentially, we are reversing a portion of the original purchase journal entry.

Medici is returning inventory, which means the balance in the inventory account is decreasing. The merchandise cost Whistling Flutes $400.įirst, let’s look at this from the perspective of Medici Music, the buyer. On August 14, Medici Music returns $700 worth of merchandise to Whistling Flutes, LLC because the wrong merchandise was received. We will also look at the transactions from the seller and buyer’s perspectives. Remember, the rules for perpetual and periodic inventory still apply so we will look at both cases here. This transaction has an effect on inventory for both the seller and the buyer, because inventory is physically moving. When this happens, the purchaser no longer has the merchandise. A return occurs when inventory is purchased and later returned to the seller.

One periodic back in focus