Concept explainers
Discounts Nelson Company bought inventory for $50,000 on terms of 2/15, n/60. It pays for the first $37,500 of inventory purchased within the discount period and pays for the remaining $12,500 two months later.
Required:
- 1. Prepare the
journal entries to record the purchase and the payment under both the (a) gross price and (b) net price methods. Assume that Nelson uses the periodic inventory system. - 2. Next Level Which of the two methods yields a conceptually preferable
valuation of inventory ?
1. (a)
Journalize the transactions of Company N under gross price method, assuming Company N uses periodic inventory system.
Explanation of Solution
Periodic inventory system: The method or system of recording the transactions related to inventory occasionally or periodically is referred as periodic inventory system.
Gross price method: Under gross price method, sales and purchases of inventory are recorded at the full invoice price (gross amount) without the deduction of discounts.
Journalize the transactions of Company N:
Date | Account title and Explanation | Post ref. | Amount | |
Debit | Credit | |||
Purchases | $50,000 | |||
Accounts payable | $50,000 | |||
(To record the purchase of inventory of $50,000 on account, credit terms of | ||||
Accounts payable | $37,500 | |||
Purchases discounts (1) | $750 | |||
Cash (2) | $36,750 | |||
(To record the payment for inventory within the discount period) | ||||
Accounts payable | $12,500 | |||
Cash | $12,500 | |||
(To record the payment for inventory after the discount period) |
Table (1)
To record the purchase of inventory of $50,000 on account, credit terms of
Purchases account is an expense and it is decreased the equity value by $50,000. Therefore, debit purchase account with $50,000.
Accounts payable is a liability and it is increased by $50,000. Therefore, credit accounts payable account with $50,000.
To record the payment for inventory within the discount period:
Accounts Payable is a liability and it is decreased because the company has paid the amount for the credit purchases. Therefore, debit Accounts Payable account with $37,500.
Purchases discount is a contra expense account to Purchase account and will have a normal credit balance. Therefore, Purchase discount account is credited with $750.
Cash is an asset and it is decreased because cash is paid for credit purchases. Therefore, credit Cash account with $36,750.
To record the payment for inventory after the discount period:
Accounts Payable is a liability and is decreased because the company has paid the amount for the credit purchases. Therefore, debit Accounts Payable account with $12,500.
Cash is an asset and it is reduced because cash is paid for credit purchases. Therefore, credit Cash account with $12,500.
Working Note 1: Compute the discount on purchases.
Credit terms: The credit terms are
Working Note 2: Compute the cash paid to accounts payable (suppliers).
1. (b)
Journalize the transactions of Company N under net price method, assuming Company N uses periodic inventory system.
Explanation of Solution
Periodic inventory system: The method or system of recording the transactions related to inventory occasionally or periodically is referred as periodic inventory system.
Net price method: Under net price method, sales and purchases of inventory are recorded at the net invoice price which means the discounts are deducted from the gross invoice price.
Date | Account title and Explanation | Post ref. | Amount | |
Debit | Credit | |||
Purchases (4) | $49,000 | |||
Accounts payable | $49,000 | |||
(To record the purchase of inventory of $50,000 on account, credit terms of | ||||
Accounts payable (5) | $36,750 | |||
Inventory | $36,750 | |||
(To record the payment for Inventory within the discount period) | ||||
Accounts payable | $12,250 | |||
Purchase discount lost | $250 | |||
Cash (6) | $12,500 | |||
(To record the payment for Inventory after the discount period) |
Table (2)
To record the purchase of inventory of $50,000 on account, credit terms of
Purchases account is an expense and it is decreased the equity value by $49,000. Therefore, debit purchase account with $49,000.
Accounts payable is a liability and it is increased by $49,000. Therefore, credit accounts payable account with $49,000.
To record the payment for Inventory within the discount period:
Accounts Payable is a liability and is decreased because the company has paid the amount for the credit purchases. Therefore, debit Accounts Payable account with $36,750.
Cash is an asset and it is reduced because amount is paid for credit purchases. Therefore, credit Cash account with $36,750.
To record the payment for Inventory after the discount period:
Accounts Payable is a liability and is decreased because the cash has paid the amount for the credit purchases. Therefore, debit Accounts Payable account with $12,250.
Purchases discount lost is a component of retained earnings and it decreases the retained earnings. Therefore, Purchase discount lost account is debited with $250.
Cash is an asset and it is reduced because amount is paid for credit purchases. Therefore, credit Cash account with $12,500.
Working Note 3: Compute the net invoice on purchases.
Credit terms: The terms are
Working Note 4: Compute the net invoice price of cash paid within the discount period.
Working Note 5: Compute the net invoice price of cash paid after the discount period.
2.
Identify among the two methods that yields a conceptually desirable valuation of inventory.
Explanation of Solution
Gross price method: Under gross price method, sales and purchases of inventory are recorded at the full invoice price (gross amount) without the deduction of discounts.
Net price method: Under net price method, sales and purchases of inventory are recorded at the net invoice price which means the discounts are deducted from the gross invoice price.
Under net price method, discount is not considered as a reduction in the inventory cost because losing the discount would not increase the amount derived from the inventory. But, in gross price method, includes the discount not taken as a part of inventory.
Hence, net price method yields a conceptually desirable valuation of inventory.
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Chapter 7 Solutions
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