Purchase Returns and Allowances

Definition

Purchase Returns and Allowances refer to the reduction in the cost of merchandise that a business has purchased from its suppliers due to items being returned or adjustments being made. This term is particularly relevant in the context of merchandising activities, income statement preparation, and recording transactions using the periodic inventory system.

5 Must Know Facts For Your Next Test

1. Purchase Returns and Allowances are recorded as a reduction to the Merchandise Purchases account, which in turn reduces the Cost of Goods Sold on the income statement.
2. The amount of Purchase Returns and Allowances is subtracted from the total Merchandise Purchases to arrive at the Net Purchases, which is then used in the calculation of Cost of Goods Sold.
3. In a Merchandising company, the multi-step income statement format includes a separate line item for Purchase Returns and Allowances to provide more detailed information about the company's purchasing activities.
4. Under the Periodic Inventory System, Purchase Returns and Allowances are recorded as a reduction to the Merchandise Purchases account, which impacts the calculation of Cost of Goods Sold at the end of the accounting period.
5. Accurate recording and reporting of Purchase Returns and Allowances is crucial for a Merchandising company to properly reflect its financial performance and cost structure.

Review Questions

• Explain how Purchase Returns and Allowances impact the Cost of Goods Sold calculation for a Merchandising company.
  • Purchase Returns and Allowances are recorded as a reduction to the Merchandise Purchases account. This, in turn, decreases the total Merchandise Purchases, which is a key component in the Cost of Goods Sold calculation. By reducing the Merchandise Purchases, the Cost of Goods Sold is also lowered, providing a more accurate representation of the company's cost structure and profitability.
• Describe the role of Purchase Returns and Allowances in the preparation of a multi-step income statement for a Merchandising company.
  • In a multi-step income statement for a Merchandising company, Purchase Returns and Allowances are reported as a separate line item, typically deducted from the Merchandise Purchases. This allows for a more detailed breakdown of the company's purchasing activities and cost structure. By isolating the impact of Purchase Returns and Allowances, the income statement provides users with a clearer understanding of the company's overall financial performance and the factors that influence its gross profit.
• Analyze how the recording of Purchase Returns and Allowances affects the periodic inventory system and the calculation of Cost of Goods Sold.
  • Under the periodic inventory system, Purchase Returns and Allowances are recorded as a reduction to the Merchandise Purchases account. This adjustment directly impacts the Cost of Goods Sold calculation at the end of the accounting period. By decreasing the total Merchandise Purchases, the Cost of Goods Sold is also reduced, providing a more accurate representation of the company's cost of goods sold and the overall profitability of its merchandising activities. The accurate recording of Purchase Returns and Allowances is crucial for the proper functioning of the periodic inventory system and the reliability of the financial statements.

Related terms

Merchandise Purchases:

The acquisition of goods or products by a business for the purpose of resale to customers.

Cost of Goods Sold (COGS): The total cost incurred by a business to acquire or manufacture the goods it has sold to customers.

Periodic Inventory System:

An inventory management system where the cost of goods sold is calculated at the end of the accounting period based on the beginning inventory, purchases, and ending inventory.