Question

Your company, which uses the perpetual method, purchases inventory for $7,000 on account. Before paying the invoice, your firm returns damaged goods for a $650 credit. What is the journal entry to record this return? debit Cost of Goods Sold; credit Inventory debit Accounts Payable; credit Cost of Goods Sold debit Accounts Payable; credit Purchase Returns and Allowances debit Purchase Returns and Allowances; credit Accounts Payable debit Accounts Payable; credit Inventory

Answer 1

First we must understand, what is Perpetual Inventory System

Let’s start with an example,

a) if we purchase goods from Mr.A on credit, usually the journal entry will be

Debit Purchase A/c

Credit Mr.A a/c (Accounts Payable)

But, in perpetual Inventory system, the journal will be

Debit Inventory a/c

Credit Mr.A a/c(Accounts Payable)  

b) If we sell goods to Mr.B on credit, usually the journal will be

            Debit Mr.B a/c

            Credit Sales a/c

But in Perpetual Inventory System, the journal will be two entries

1.                 Debit Mr.B (Accounts Receivable) (for sales value)

Credit Sales a/c

2.                 Debit Cost of Goods sold a/c (Sales – Profit)

Credit Inventory a/c

What do you understand from the above example?

Under Perpetual Inventory system inventory accounts get updated after each purchase or sale.

Inventory quantities are updated continuously.

Your Question

Your company, which uses the perpetual method, purchases inventory for $7,000 on account. Before paying the invoice, your firm returns damaged goods for a $650 credit.

What is the journal entry to record this return?

1. Debit Cost of Goods Sold; Credit Inventory
2. Debit Accounts Payable; Credit Cost of Goods Sold
3. Debit Accounts Payable; Credit Purchase Returns and Allowances
4. Debit Purchase Returns and Allowances; Credit Accounts Payable
5. Debit Accounts Payable; Credit Inventory (answer)

Let’s see the reason for the answer

1. Debit Cost of Goods Sold; Credit Inventory (wrong answer)

(Because under Perpetual Inventory system this is the entry is made for sale of goods)

2. Debit Accounts Payable; Credit Cost of Goods Sold (wrong answer)

(At no instance we make this entry)

3. Debit Accounts Payable; Credit Purchase Returns and Allowances (wrong answer)

(Because it is usual entry in accounting for purchase return)

4. Debit Purchase Returns and Allowances; Credit Accounts Payable (wrong answer)

(Purchase returns are never debited. They are always credited)

5. Debit Accounts Payable; Credit Inventory (Correct answer)

(Because party account(accounts payable) is debited when company returns the goods and immediately inventory ledger is updated by crediting inventory account for the goods gone out under Perpetual Inventory System)