Accounting for Purchase Returns and Allowances under the Periodic and Perpetual Inventory Systems

✦ Purchase returns and allowances reduce the cost of inventory purchased and must be accounted for accurately to reflect correct inventory valuation and cost of goods sold (COGS).

✦ Under both periodic and perpetual inventory systems, these transactions adjust either the purchases account or directly impact inventory balances.

✦ Proper accounting ensures accurate gross profit calculation and correct matching of expenses with revenues.

✦ Timely recognition of returns and allowances prevents overstating inventory and expenses.

1. What Are Purchase Returns and Allowances?

✦ Purchase returns occur when a company returns previously purchased inventory to suppliers.

✦ Purchase allowances involve price reductions granted by suppliers for defective or unsatisfactory inventory without returning the goods.

✦ These adjustments reduce the total cost of purchases and directly affect inventory or COGS, depending on the inventory system used.

2. Accounting Under the Periodic Inventory System

✦ Under the periodic system, purchases are recorded in a Purchases account rather than directly adjusting inventory.

✦ Returns and allowances are recorded in a Purchase Returns and Allowances account, reducing total purchases.

Entry for purchase return:

debit Accounts Payable – $2,000

credit Purchase Returns and Allowances – $2,000

✦ At the end of the period, total purchases are adjusted to compute COGS.

3. Accounting Under the Perpetual Inventory System

✦ Under the perpetual system, all inventory transactions directly adjust the Inventory account.

✦ Returns reduce the inventory balance immediately when processed.

Entry for purchase return:

debit Accounts Payable – $2,000credit Inventory – $2,000

✦ No separate Purchase Returns and Allowances account is maintained under the perpetual system.

4. Impact on Financial Statements

✦ Periodic system:

 • Reduces net purchases in the COGS calculation.

 • COGS = Beginning Inventory + Net Purchases – Ending Inventory

✦ Perpetual system:

 • Reduces inventory directly and impacts real-time inventory balances.

 • COGS continuously updated with each sale and return.

5. Allowances Without Physical Return

✦ When goods are not returned but a price reduction is granted:

Entry (both systems):

debit Accounts Payable – $1,500

credit Purchase Allowances – $1,500 (Periodic)

credit Inventory – $1,500 (Perpetual)

✦ If payment has already been made, debit Cash or Accounts Receivable instead of Accounts Payable.

6. Disclosure Requirements

✦ Disclose material purchase returns and allowances if they significantly impact inventory valuation or gross margin.

✦ Present net purchases clearly in the income statement if using the periodic system.

7. IFRS Comparison (IAS 2)

Topic	US GAAP (ASC 330 / ASC 705)	IFRS (IAS 2)
Treatment under periodic system	Purchase Returns and Allowances	Same
Treatment under perpetual system	Direct adjustment to inventory	Same
Disclosure	Required if material	Required if material
Allowances treatment	Reduce cost of purchases/inventory	Same

8. Common Errors

✦ Failing to adjust inventory balances immediately under the perpetual system.

✦ Omitting purchase returns from COGS calculation under the periodic system.

✦ Misclassifying allowances as income instead of reducing inventory cost.

✦ Recording returns after period-end without adjusting ending inventory appropriately.

✦ Ignoring disclosure of significant returns and allowances affecting financial results.