In accounting, the net method likely refers to the way a company records each vendor’s invoice that offers an early payment discount. There are two types of purchase discounts and the accounting treatment for these two discounts is different from one and another. The cash discount forfeited is transferred as other income to the profit and loss account. Notice that we did not post the purchases to the inventory account, which is a major difference between this periodic system and the perpetual system. The perpetual system is what we will be doing in the next unit as we study the perpetual system.

So 40 units went back to Bryan and the accounting department received a credit memo for $4,000. They also paid shipping of some amount that will be posted to a shipping expense account that is not part of COGS. Also, we are going to make some adjustments in the next section for returns, allowances, and discounts; but first, let’s check in on recording purchases. If the payment is made within the discount period, Accounts Payable should be debited, and Cash should be credited for the amount at which the payable was originally recorded.

For reporting purposes, purchases discounts are subtracted from purchases to arrive at net purchases, while purchases discounts lost are recorded as an expense following the gross profit number for a particular period. Accounting for purchase discounts, we can be recorded under either the net method or the gross method. Both methods provide the same result; however, the accounting journal entry is slightly different. For many purchases, such as supplies and travel, certain members of the company may have company credit cards.

Net Method

Examining all aspects and looking at both the long-term results and short-term gains before deciding which course of action to take will provide the most clarity when it comes time to make a decision. Generally speaking, if one way will require more work to complete but will result in higher quality outcomes, this should definitely be considered in the process. Still, other methods might save time but require more resources or take longer to execute. Choosing the right method for your business is an important task that should not be taken lightly. When it comes to businesses, having the correct methodology in place can mean the difference between success and failure.

However, if the invoice is not paid within the discount period, an adjusting entry needs to be made under the net method in order to recognize the loss on the discount. By recording this adjustment, the accounts payable need to be adjusted back to the full invoice amount. In this method, the discount received is recorded as the reduction in merchandise inventory. Therefore, the amount of discount is recorded on credit to the merchandise inventory account.

The AP clerk makes sure the packing slip matches the invoice and then processes the whole thing (often called a voucher) for payment. The terms usually require Home Depot to pay within 30 days and there is often a discount for paying early, maybe up to two percent. The net method assumes that every customer will pay in time to receive a sales discount. At the time of a sale, record the discounted invoice amount in your accounting journal. Debit the accounts receivable account by the discounted invoice amount to increase this account by the amount you expect to collect.

Cash Discounts/Purchase Discounts

The Gross Method results in a lower cost of goods sold figure, which can impact several places on your financial statements including net income and inventory valuation. It also helps to ensure that expenses accurately reflect payments made during a period. A quick stroll through most any retail store will reveal a substantial investment in inventory. Even if a merchant is selling goods at a healthy profit, financial difficulties can creep up if a large part of the inventory remains unsold for a long period of time. Therefore, a prudent business manager will pay very close attention to inventory content and level.

The Metro company uses net price method to record the purchase of inventory. If you’re a business owner, it’s essential to understand the difference between the net method and gross method of accounting for purchase discounts. If the company’s policy is to pay all vendor invoices within the discount period, the net method will result in a more precise current liability amount on its balance sheet. It also means that the accounts and amounts recorded as debits will better reflect the historical cost principle. In contrast, there is no journal entry is required under the gross method as the transaction was recorded at the gross amount at the date of purchase and the company would make the full payment without the discount.

Determining a Sales Discount

Conversely, the perpetual inventory system involves more constant data update and is a far superior business management tool. The following presentation begins with a close examination of the periodic system. The overall monetary impact on financials of the company remains the same under both these methods once the entire transaction flow from sales to payment is complete. The difference is primarily in timing of impact and disclosure in financial statements. This will particularly have impact when such sales transactions are recorded across financial statements. Net method of cash discount is the accounting method in which sales are accounted for assuming the cash discount will be availed by the customer.

Purchase Considerations For Merchandising Businesses

Gross method of cash discount is the accounting method in which sales are accounted for at invoice value and cash discount is separately accounted for when availed by the customer. In accounting, purchases are the amount of goods a company buys over the course of the year. It also refers to information that should be recorded about the kind, quality, quantity, and cost of goods that are purchased and added to inventory. Purchases are offset by Purchase Discounts, and also Purchase Returns and Allowances. When purchases should be added to inventory depends on the Free On Board (FOB) policy of the trade.

Credit the “sales discounts forfeited” account by the same amount to record the additional revenue. Perpetual inventory system is a technique of maintaining inventory records that provides a running balance of cost of goods available for sale and cost of goods sold for a period. Under this system, no purchases account is maintained because inventory account is directly debited with each purchase of merchandise. Under perpetual inventory system, the expenses that are incurred to obtain merchandise inventory are added to the cost of merchandise available for sale.

Again, this method depends on the arrangement you have with the bank and other credit card servicing vendors. Cash discounts for prompt payment are not usually available on freight charges. For example, if there was a 2% discount on the above purchase, it would amount to $200 ($10,000 X 2%), NOT $208 ($10,400 X 2%). Take a moment and look at the invoice presented earlier in this chapter for Barber Shop Supply. Just to the right of the invoice date, note that the terms were F.O.B. Dallas. This means that Barber Shop Supply is responsible for getting the goods to the customer in Dallas.

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