Purchase Discounts, Returns and Allowances: All You Need To Know

The accounts normally have a credit balance and in use are offset against the purchases account which is normally a debit balance. The net balance of the accounts shows the net value of the purchases made by the business for the accounting period. Purchase Discounts, Returns and Allowances are contra expense accounts with a credit balance that reduce the normal debit balance of the main Purchase Expense account in order to present the net value of purchase expenses in a company’s income statement. Contra equity is a general ledger account with a debit balance that reduces the normal credit balance of a standard equity account to present the net value of equity in a company’s financial statements. Examples of equity contra accounts are Owner Draws and Repurchased Treasury Stock Shares. Sales Discounts, Returns and Allowances are contra revenue accounts with a debit balance that reduce the normal credit balance of the main Sales Revenue account in order to present the net value of sales generated by a business in the revenue section of the company’s income statement.

• The net balance of the accounts shows the net value of the purchases made by the business for the accounting period.
• To account for these returns and allowances, TechGadget records the amount in a contra revenue account called “Sales Returns and Allowances.” On the income statement, the net sales revenue will be reported as $77,000 ($80,000 – $3,000).
• The purchase discounts account will have a credit balance of $2,000 (2% of $100,000), which represents the discount received from the supplier.
• Since 2014, she has helped over one million students succeed in their accounting classes.
• Let’s consider a fictional example of a small business called “TechGadget” to illustrate the use of contra accounts in financial accounting.

Income Statements for Merchandising Companies and Cost of Goods Sold

• The following are examples of contra expense accounts used in double entry bookkeeping.
• They also help organizations track specific adjustments and discrepancies, allowing for better financial analysis and decision-making.
• He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries.
• An estimate of bad debts is made to ensure the balance in the Accounts Receivable account represents the real value of the account.
• When the two balances are offset against each other they show the net balance of both accounts.

This is important for accurate financial reporting and compliance with… Under the periodic method, we do not update the value in the inventory account until we do the adjusting entries at the end of the period. Therefore, we should never use the inventory account in purchase transactions for companies that use the periodic method. We all love discounts, but why would a business offer offer a discount on their products? Typically, a business might offer a discount to increase sales, make an unhappy customer happy or incentivize a customer to pay quickly. Credit Cash in the contra account purchases discount has a normal debit balance. Bank if a sales return or allowance involves a refund of a buyer’s payment.

Is a Contra Account a Debit or Credit?

The discount is recorded in a contra expense account which is offset against the appropriate purchases or expense account in the income statement. The first section of an income statement reports a company’s sales revenue, purchase discounts, sales returns and cost of goods sold. This information directly affects a company’s gross and operating profit. A purchase discount is a small percentage discount a company offers to a buyer to induce early payment of goods sold on account.

Equity Contra Account

The Sales Discounts, Returns, Allowances contra revenue sales accounts may be presented on the income statement as individual line items or–if immaterial or preferable–aggregated into a single contra-revenue line. A common example of a purchase discount are the NET D payment terms, such as 2/10 Net 30, where a buyer receives a 2% discount if an invoice is paid early within 10 days, otherwise a full payment is due in 30 days. When working with discounts, we generally calculate the discount and record it at the time of payment. Some textbooks may show you two different methods for recording the discount, one in which the discount is recorded at the time of the purchase and one where the discount is recorded at the time of the payment. When you record the discount at the time of the purchase and the discount is not taken because the buyer does not pay within the discount window, we must alter the payment entry to undo the discount taken in the first entry. By recording the discount at the time of the payment, we are only recording a discount that has actually been taken and we never need to undo something from the first entry.

What is a Contra Expense?

A contra account is one which is offset against another account. So for example there are contra expense accounts such as purchase returns, contra revenue accounts such as sales returns and contra asset accounts such as accumulated depreciation. Purchase returns, allowances and discounts are all examples of contra expense accounts.

Example of a Contra Expense

• When an account has a balance that is opposite the expected normal balance of that account, the account is said to have an abnormal balance.
• The full amount owed to the supplier is shown as a balance sheet liability (accounts payable) and included as purchases or expenses in the income statement.
• The Sales Discounts, Returns, Allowances contra revenue sales accounts may be presented on the income statement as individual line items or–if immaterial or preferable–aggregated into a single contra-revenue line.
• A contra sales revenue account–such as Sales Allowances, Returns and Discounts-has a debit balance because it is contrary to the credit balance of a regular Sales Revenue account.
• The total purchase was $5,000 (with a cost of $3,000), terms 3/10, n/30.
• I have had students do the problem perfectly, except they give me the journal entries for the purchase when I ask for the sale or vice versa.
• The value of Inventory dropped $3,000, which moves to the income statement as an expense.

The ‘interest rate’ for the 20 days is calculated as follows. The purchase discount is based on the purchase price of normal balance the goods and is sometimes referred to as a cash discount on purchases, settlement discount, or discount received. We will look at this transaction under both methods so you can see the difference. Before we start looking at each method, let’s start by discussing what is the same under each of the methods. The first transaction deals with the purchase of the inventory. The second transaction deals with the payment for the instruments already received.

• After 30 days, your payment is now late and the seller can add on late charges or interest, depending on state law.
• The offset to the Depreciation Expense account is Accumulated Depreciation.
• This process continues each year until the equipment is fully depreciated.
• Instead of focusing on the fear and anger, she started her accounting and consulting firm.
• The company uses Straight-Line Depreciation to track the loss of value of the asset over time.
• We will use a contra account, Sales Discounts, to record the discount amount.

Spend extra time if needed to make sure that you understand what the transaction actually means. Do not jump right into the entries until you know what is happening in the transaction. Typically, a problem will state which company you should do the entries for. Go back through the transactions to see if the company is the buyer or seller. Sometimes, I will even note that when I am reading the problem. Read the transactions carefully or you may lose a lot of points on a Accounting Security problem you know how to do.

What are Contra Accounts?

Let’s look at both entries together, since we already discussed the methodology. Again, the only difference is that we do not track the changes in inventory under the periodic system. Medici Music purchases instruments to sell in its stores from Whistling Flutes, LLC on August 13. The total purchase was $5,000 (with a cost of $3,000), terms 3/10, n/30. Record the necessary journal entries for Whistling Flutes, LLC.