---
title: "Purchase Allowances | Financial Accounting I"
description: "Purchase allowances reduce the recorded cost of damaged or defective merchandise, keeping inventory and cost of goods sold accurate in Financial Accounting I."
canonical: "https://fiveable.me/financial-accounting/key-terms/purchase-allowances"
type: "key-term"
subject: "Financial Accounting I"
---

# Purchase Allowances | Financial Accounting I

## Definition

Purchase allowances are reductions in the purchase price of merchandise because of defects, damage, or similar problems. In Financial Accounting I, they lower the inventory cost recorded by the buyer without sending the goods back.

## What It Is

Purchase allowances are price reductions a seller gives a buyer after the buyer receives merchandise that is damaged, defective, or not quite what was ordered. In Financial Accounting I, you use them to adjust the cost of inventory when the goods stay with the buyer instead of being returned.

That makes purchase allowances different from a discount at the time of sale. The buyer already recorded the purchase at the original invoice amount, then later gets a credit memo or allowance from the seller for part of the value. The accounting entry reduces the inventory account if the goods are still on hand, or reduces Cost of Goods Sold if some of the goods have already been sold.

Under a perpetual inventory system, this matters because the inventory records are updated right away. If a company receives damaged merchandise and negotiates a $500 allowance, the company does not keep inventory on the books at the full original cost. Instead, the inventory value is adjusted down so the records show the true cost of the goods actually kept.

A simple example helps. Suppose a company buys merchandise for $4,000 on account, then later gets a $300 allowance because part of the shipment was scratched but still usable. The buyer keeps the goods and records the reduction as a credit to the purchase cost. If the goods are still in inventory, the inventory balance becomes $3,700, not $4,000.

The biggest thing to watch is the difference between an allowance and a return. With a purchase return, the merchandise goes back to the seller. With a purchase allowance, the buyer keeps the merchandise and gets a partial refund or credit for the reduced value. That distinction changes the journal entry, but both transactions lower the buyer’s net purchase cost.

## Why It Matters

Purchase allowances show up in the core merchandise purchase cycle, which is a big part of Financial Accounting I. If you record them incorrectly, your inventory balance, accounts payable, and Cost of Goods Sold can all end up wrong.

This term also connects directly to the perpetual inventory system. Since perpetual records update inventory after every purchase, sale, return, or allowance, the allowance entry has to reflect the goods the company actually keeps. That keeps the balance sheet and income statement closer to reality.

You also need this term to read business transactions the right way. When a problem says merchandise arrived damaged but the buyer kept it for a reduced price, that is a purchase allowance, not a return. That one detail changes whether you debit Accounts Payable, Inventory, or Cost of Goods Sold, and it changes the amount reported as merchandise cost.

In a problem set, this concept usually shows up as part of a journal entry or a net merchandise cost calculation. In a real company, it helps management track vendor issues and make sure profit is not overstated because inventory stayed on the books at the wrong amount.

## Connections

### [Purchase Returns](/financial-accounting/key-terms/purchase-returns)

Purchase returns happen when the buyer sends the merchandise back to the seller. Purchase allowances happen when the buyer keeps the goods and gets a price reduction instead. If a problem says the goods were not returned, that usually points you toward an allowance instead of a return.

### Perpetual Inventory System

In a perpetual system, inventory is updated continuously, so an allowance changes the inventory records right away if the goods are still on hand. That makes the journal entry more specific than in a simple periodic system, because the company tracks the reduced cost item by item or transaction by transaction.

### Cost of Goods Sold (COGS)

If the damaged merchandise has already been sold, the allowance can affect Cost of Goods Sold instead of ending inventory. That is why you have to know whether the goods are still in inventory when the allowance is received. The timing changes where the reduction goes.

### [Accounts Payable](/financial-accounting/key-terms/accounts-payable)

When merchandise was bought on credit, an allowance often reduces the amount the buyer owes the seller. The credit memo can lower Accounts Payable instead of requiring cash, which keeps the liability balance accurate after the seller agrees to the price reduction.

## On the AP Exam

A quiz or problem-set question will usually give you a purchase scenario and ask for the correct journal entry, net cost, or inventory balance. Your job is to spot that the merchandise stayed with the buyer, then record the allowance as a reduction of the purchase cost or liability. If the goods are still unsold, the inventory account is lowered. If the goods have already been sold, the reduction can flow into Cost of Goods Sold instead. The common trap is treating an allowance like a return and removing the merchandise completely. Read the wording closely, especially phrases like damaged but kept, partial credit, or price reduction.

## Purchase Allowances vs Purchase Returns

These are easy to mix up because both lower the buyer’s net purchase cost. Purchase returns mean the merchandise goes back to the seller, while purchase allowances mean the buyer keeps the merchandise and receives a partial credit. If the problem says the company kept the goods, you are dealing with an allowance.

## Key Takeaways

- Purchase allowances are price reductions for merchandise the buyer keeps after receiving damaged or defective goods.
- In Financial Accounting I, an allowance lowers the recorded cost of inventory or, if the goods were already sold, it may affect Cost of Goods Sold.
- The allowance usually reduces Accounts Payable when the original purchase was on credit.
- Do not confuse a purchase allowance with a purchase return, because returns involve sending the merchandise back.
- The main skill is reading the transaction carefully so you know whether to adjust inventory, liability, or cost of goods sold.

## FAQs

### What is Purchase Allowances in Financial Accounting I?

Purchase allowances are reductions in the amount a buyer pays for merchandise that was damaged, defective, or otherwise not worth the full invoice price. In Financial Accounting I, they lower the recorded cost of the goods without requiring the merchandise to be returned.

### How do purchase allowances affect journal entries?

The allowance usually reduces Accounts Payable if the purchase was on account, or it can reduce cash owed to the seller through a credit memo. If the merchandise is still in inventory, the inventory account is lowered too. The exact account depends on whether the goods are still on hand.

### What is the difference between purchase allowances and purchase returns?

A purchase return means the buyer sends the goods back to the seller. A purchase allowance means the buyer keeps the goods and gets a partial price reduction. That one difference changes the accounting entry and the wording you should look for in a problem.

### Can purchase allowances affect cost of goods sold?

Yes, if the merchandise has already been sold before the allowance is granted, the reduction may affect Cost of Goods Sold instead of inventory. If the goods are still unsold, the inventory balance is usually reduced. Timing matters a lot in perpetual inventory.

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