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Periodic Purchases (App 5A)

🎯 Learning Objectives

  • Understand the periodic inventory system and its key characteristics
  • Distinguish between perpetual and periodic inventory systems
  • Record purchases, purchase returns, and purchase discounts in a periodic system
  • Calculate net purchases and understand freight-in treatment
  • Prepare adjusting entries for inventory at period-end

📚 Background & Principles

In a periodic inventory system, the Inventory account is not updated with each purchase or sale. Instead, all purchases are recorded in temporary "Purchases" accounts throughout the period, and the actual inventory balance is determined only at year-end through physical counting.

Core Principle: The periodic system separates the recording of purchases from the inventory asset. Purchases are tracked in temporary accounts, and only at period-end is the true inventory balance determined and COGS calculated.

This system is simpler to implement but provides less real-time information about inventory levels. It works well for businesses with lower transaction volumes or less valuable inventory.

💡 Key Insight: The periodic system is like putting all your receipts in a box during the year and only counting your actual inventory at year-end to see what you have left. The difference between what you started with plus what you bought minus what you have left tells you what you sold.

🔑 Key Concepts

Purchases Account

Temporary debit account that records the cost of all goods purchased for resale during the period. Closed at year-end.

Purchase Returns and Allowances

Contra-purchases account with credit balance. Records goods returned to suppliers or price adjustments granted.

Purchase Discounts

Contra-purchases account with credit balance. Records savings from early payment under credit terms.

Freight-In

Temporary debit account for shipping costs paid by the buyer. These costs are part of inventory cost.

Net Purchases

Gross Purchases minus Purchase Returns and Allowances minus Purchase Discounts. Plus Freight-In equals cost of goods available for sale.

Physical Inventory Count

Year-end process of counting actual inventory on hand. Used to determine ending inventory and COGS.

🔍 Deep Dive

Explore periodic purchases at different levels of depth:

🟢 Foundational Level

Understanding the periodic system "Receipt Box" analogy.

The Receipt Box Analogy

Analogy: The Temporary Boxes

Imagine you're cleaning your room all year but don't actually organize anything until December.

During the Year:

Instead of putting clothes in your closet immediately, you throw them in a "Dirty Clothes" pile (Purchases).

Returns?

If you return something to the store, you put the receipt in a separate "Returns" box (Purchase Returns).

Year-End (December):

You finally count what you actually have in your closet (Physical Count), then calculate what you must have worn/worn out.

📦 Purchases

All purchase receipts

↩️ Returns

Returned items

💰 Discounts

Early payment savings

🚚 Freight-In

Shipping costs

Net Purchases Formula

Net Purchases = Gross Purchases - Returns - Discounts

🟡 Standard Level

Recording transactions and understanding account treatment.

Recording Purchase Transactions

Scenario: Company purchases $10,000 of merchandise on credit, terms 2/10, n/30. Freight costs $500.

Entry 1: Purchase (Credit)
Debit: Purchases $10,000
Credit: Accounts Payable $10,000
Entry 2: Freight Payment
Debit: Freight-In $500
Credit: Cash $500
Entry 3: Early Payment (within 10 days)
Debit: Accounts Payable $10,000
Credit: Cash $9,800
Credit: Purchase Discounts $200

Recording Purchase Returns

Scenario: Company returns $1,000 of defective merchandise to supplier.

Return Entry:
Debit: Accounts Payable $1,000
Credit: Purchase Returns and Allowances $1,000
Why contra account?

Purchase Returns and Allowances has a credit balance (normal for contra-purchases). This reduces total purchases for COGS calculation.

🔴 Advanced Level

Complex scenarios and period-end adjustments.

Year-End COGS Calculation

Scenario: Beginning Inventory $15,000, Gross Purchases $80,000, Purchase Returns $3,000, Purchase Discounts $1,500, Freight-In $2,500, Physical Count Ending Inventory $18,000.

Step 1: Calculate Net Purchases

Net Purchases = $80,000 - $3,000 - $1,500 = $75,500

Step 2: Calculate Cost of Goods Available

Available = Beginning + Net Purchases + Freight-In

Available = $15,000 + $75,500 + $2,500 = $93,000

Step 3: Calculate COGS

COGS = Available - Ending Inventory

COGS = $93,000 - $18,000 = $75,000

Adjusting Entry at Year-End

After physical count shows $18,000 ending inventory:

Adjusting Entry:
Debit: Cost of Goods Sold $75,000
Debit: Purchase Returns and Allowances $3,000
Debit: Purchase Discounts $1,500
Debit: Freight-In $2,500
Credit: Purchases $80,000
Credit: Inventory (Ending) $18,000
Alternative (simpler) entry:
Debit: Cost of Goods Sold $75,000
Credit: Inventory (Ending) $18,000
Credit: Purchases $57,000

🎨 Interactive: Net Purchases Calculator

Calculate net purchases by entering your gross purchases and adjusting for returns, discounts, and freight.

$50,000
−
$2,000
−
$1,000
+
$1,500
Net Purchases
$48,500

📊 Perpetual vs Periodic: Purchases Comparison

Understanding how the same transaction is recorded differently in each system.

Transaction Perpetual Entry Periodic Entry
Purchase $1,000 goods on credit
Dr: Inventory $1,000
Cr: Accounts Payable $1,000
Updates inventory immediately
Dr: Purchases $1,000
Cr: Accounts Payable $1,000
Temporary purchases account
Return $200 of goods
Dr: Accounts Payable $200
Cr: Inventory $200
Reduces inventory account
Dr: Accounts Payable $200
Cr: Purchase Returns $200
Contra-purchases account
Pay $50 freight on purchase
Dr: Inventory $50
Cr: Cash $50
Capitalized in inventory
Dr: Freight-In $50
Cr: Cash $50
Temporary account
Pay within discount period (2% discount)
Dr: Accounts Payable $1,000
Cr: Cash $980
Cr: Inventory $20
Reduces inventory cost
Dr: Accounts Payable $1,000
Cr: Cash $980
Cr: Purchase Discounts $20
Contra-purchases account

🚫 Common Misconceptions & Professional Tips

❌ Misconception 1: "Purchases account shows the inventory asset."

✅ Reality: Purchases is a TEMPORARY expense-type account, not the Inventory asset. In periodic systems, the actual Inventory account (asset) is only updated at year-end. Purchases tracks what you bought, not what you have.
❌ Misconception 2: "Freight-In is an expense."

✅ Reality: Freight-In is a temporary account that gets added to inventory cost. It's not a period expense—it ultimately becomes part of COGS when inventory is sold, or remains in Ending Inventory if unsold.
❌ Misconception 3: "Periodic systems are obsolete."

✅ Reality: Periodic systems are still used by small businesses, retailers with low inventory turnover, and organizations where the cost of perpetual systems exceeds benefits. They're simpler and cheaper to maintain.
💡 Professional Tip #1: Keep all purchase invoices and freight bills organized throughout the year. They'll be needed for year-end inventory valuation and audit purposes.
💡 Professional Tip #2: Reconcile purchase accounts monthly. Large or unusual entries in Purchases, Returns, or Discounts may indicate errors or fraud.
💡 Professional Tip #3: Physical inventory counts should be done carefully and independently. Use count teams and pre-numbered count sheets to ensure accuracy.

🧠 Memory Aids & Quick Reference

⚡ Quick Recall: Net Purchases Formula

Net Purchases = Gross Purchases − Purchase Returns − Purchase Discounts

Cost of Goods Available = Beginning Inventory + Net Purchases + Freight-In

COGS = Cost of Goods Available − Ending Inventory

📦 Purchases (Dr)

Temporary account. Debit for all goods purchased. Closed at year-end.

↩️ Purchase Returns (Cr)

Contra-purchases. Credit for goods returned to suppliers.

💰 Purchase Discounts (Cr)

Contra-purchases. Credit for early payment savings.

🚚 Freight-In (Dr)

Temporary account. Debit for shipping costs. Part of inventory cost.

📖 Glossary

Purchases Account

Temporary debit account recording cost of goods purchased for resale during the period. Closed at year-end.

Purchase Returns and Allowances

Contra-purchases account with credit balance. Records goods returned or price adjustments from suppliers.

Purchase Discounts

Contra-purchases account with credit balance. Records savings from early payment under credit terms.

Freight-In

Temporary debit account for transportation costs on purchases. Added to inventory cost.

Net Purchases

Gross Purchases minus Purchase Returns and Allowances minus Purchase Discounts.

Periodic Inventory System

Inventory system where inventory is not updated continuously. Balance determined by physical count at period-end.

Cost of Goods Available for Sale

Beginning Inventory + Net Purchases + Freight-In. Total cost of all goods that could have been sold.

Physical Inventory Count

Year-end process of counting actual inventory on hand to determine ending inventory balance.

🎯 Final Knowledge Check

Test your understanding of Periodic Purchases:

Question 1: In a periodic system, when goods are purchased, which account is debited?



Question 2: Purchase Returns and Allowances has what normal balance?



Question 3: Freight-In is best described as:



Question 4: When is the Inventory account updated in a periodic system?



Question 5: Net Purchases equals: