Question

Nelson Company bought inventory for $42,000 on terms of 2/15, n/60. It pays for the first $31,500 of inventory purchased within the discount period and pays for the remaining $10,500 two months later.

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?

Answer 1

Solution:

Part 1 --- the journal entries to record the purchase and the payment under both the (a) gross price

Under the gross method, the purchases/sales are recorded at its cost/sales price without decreasing the amount of probable purchase/cash discount. Later on when the company pays within the terms of availing cash discount, the discount is recorded separately in the entry on the date of payment done.

	General Journal	Debit	Credit
At the date of purchase	Purchases	$42,000
	Accounts Payable		$42,000
At the date of first payment	Accounts Payable	$31,500
	Purchase Discount (Bal fig)		$630
	Cash (31,500*98%)		$30,870
At the date of last payment	Accounts Payable	$10,500
	Cash		$10,500

Journal entries to record the purchase and the payment under both the (b) net price methods. Assume that Nelson uses the periodic inventory system.

Net Method is a way to record purchase or sales with a cash discount. The net method assumes that customer always takes advantage of the discounted cash price and record the sale or purchase at the discounted price.

General Journal	Debit	Credit
Purchases (42,000*98%)	$41,160
Accounts Payable		$41,160
Accounts Payable	$30,870
Cash (31,500*98%)		$30,870
Accounts Payable (10500*98%)	$10,290
Purchase Discount Lost (bal fig)	$210
Cash		$10,500

Next Level Which of the two methods yields a conceptually preferable valuation of inventor

The net price method yields the conceptually preferable inventory valuation since gross price method includes any discounts not taken as part of inventory and the net price method treats any discount which is not taken as a period expense because losing the discount does not increase the economic benefit.

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