Page 246 - Accounting Principles (A Business Perspective)

6. Merchandising transactions

per cent per year for 20 days is USD 65.33, calculated as (USD 9,800 x .12 x 20/360). You would save USD 134.67
(USD 200 - USD 65.33) by borrowing the money and paying the invoice within the discount period.
In terms of an annual rate of interest, the 2 per cent rate of discount for 20 days is equivalent to a 36 per cent

annual rate: (360/20) X 2 per cent. The formula is:

You can convert all cash discount terms to their approximate annual interest rate equivalents by use of this
formula. Thus, a company could afford to pay up to 36 per cent [(360/20) X 2 per cent] on borrowed funds to take
advantage of discount terms of 2/10, n/ 30. The company could pay 18 per cent on terms of 1/10, n/30.

Purchase returns and allowances A purchase return occurs when a buyer returns merchandise to a seller.
When a buyer receives a reduction in the price of goods shipped, a purchase allowance results. Then, the buyer
commonly uses a debit memorandum to notify the seller that the account payable with the seller is being reduced
(Accounts Payable is debited). The buyer may use a copy of a debit memorandum to record the returns or
allowances or may wait for confirmation, usually a credit memorandum, from the seller.
Both returns and allowances reduce the buyer's debt to the seller and decrease the cost of the goods purchased.
The buyer may want to know the amount of returns and allowances as the first step in controlling the costs incurred
in returning unsatisfactory merchandise or negotiating purchase allowances. For this reason, buyers record
purchase returns and allowances in a separate Purchase Returns and Allowances account. If Hanlon

returned USD 350 of merchandise to Smith Wholesale before paying for the goods, it would make this journal
entry:
Accounts Payable (-L) 350
Purchase Returns and Allowances (+SE) 350
To record return of damaged merchandise to supplier

The entry would have been the same to record a USD 350 allowance. Only the explanation would change.
If Hanlon had already paid the account, the debit would be to Cash instead of Accounts Payable, since Hanlon
would receive a refund of cash. If the company took a discount at the time it paid the account, only the net amount
would be refunded. For instance, if a 2 per cent discount had been taken, Hanlon's journal entry for the return
would be:
Cash (+A) 343
Purchase Discounts (-SE) 7
Purchase Returns and Allowances (+SE) 350
To record return of damaged merchandise to supplier and
record receipt of cash.

Purchase returns and allowances is a contra account to the Purchases account, and the income statement shows
it as a deduction from purchases. When both purchase discounts and purchase returns and allowances are deducted
from purchases, the result is net purchases.
Transportation costs are an important part of cost of goods sold. To understand how to account for
transportation costs, you must know the meaning of the following terms:

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