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

Accounting for Purchase Discounts, Returns and Allowances

Emilie N.- FCCA, CB, MBS
Emilie N.- FCCA, CB, MBS

Emilie is a Certified Accountant and Banker with Master's in Business and 15 years of experience in finance and accounting from corporates, financial services firms - and fast growing start-ups.

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Contents

What are Purchase Discounts, Returns and Allowances?

Purchase Discounts, Returns and Allowances are contra expense accounts with a credit balance, which are used to offset the Purchase expense account that normally carries a debit balance in order to report the net value of purchases made by a business in an accounting period on its income statement.

Another example of contra expense accounts are Reimbursable Expenses

Purchase Discounts is a contra expense account with a credit balance that records the value of purchase cost deductions granted by a seller if a buyer makes a payment within an allowable time period, used as an incentive to encourage prompt payment of invoices.

Purchase discounts are also interchangeably referred to as:

  • cash discounts
  • (early or prompt) settlement discounts
  • (early or prompt) payment discounts

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.

Purchase Returns, or Returns Outwards, is a contra expense account with a credit balance used by a buyer to record the value of previously purchased goods returned to a seller due to being damaged, defective, or otherwise undesirable.

Purchase Allowances is a contra expense account with a credit balance that records the value of purchase cost deductions granted by a seller in exchange for a buyer retaining damaged, incorrect or otherwise faulty goods instead of returning them to the seller.

Debit or Credit?

Purchase Discounts, Returns and Allowances are contra expense accounts that carry a credit balance, which is contrary to the normal debit balance of regular expense accounts.

In the accounting general ledger, the credit balances of the contra purchase expense accounts reduce and offset the usual debit balances reported in the standard purchase expense accounts.

Debit or Credit? – Purchase Returns, Discounts and Allowances [Contra Expense Accounts]
Account Name Account Type Debit Credit
Purchases Parent expense account Increase Decrease
Purchase Discounts, Returns and Allowances Contra expense account Decrease Increase

Journal Entry

When a seller grants a discount, refund or an allowance to a buyer, the buyer will credit the respective Purchase Discounts, Returns or Allowances contra-expense account and debit the same amount to an Accounts Payable liability account or a Bank asset account in case of a payment refund.

A buyer debits Accounts Payable if the original purchase was made on credit and the payment has not yet been made to a seller.

This is because the initial journal posting at the time purchase was a debit to Purchase Expenses and a credit to the Accounts Payable liability account.

Discounts, Returns and Allowances on Credit Purchases
Account Name Account Type Financial Statement Debit Credit
Accounts Payable Liability Balance Sheet $$$
Purchase Discounts, Returns and Allowances Contra Expense Income Statement $$$

A buyer debits Cash in Bank if a purchase return or allowance involves a refund of a payment that the buyer has already made to a seller.

Cash Refunds for Purchase Returns and Allowances
Account Name Account Type Financial Statement Debit Credit
Cash in Bank Asset Balance Sheet $$$
Purchase Returns and Allowances Contra Expense Income Statement $$$

Financial Statements

Contra accounts for purchase expenses like Purchase Discounts, Returns and Allowances are presented in the income statement as a deduction from the gross Purchases made by a business in an accounting period, which results in the net Purchase Expense after discounts, returns and allowances.

Purchase Discounts, Returns, Allowances and other contra expense accounts may be presented on the income statement as individual line items or aggregated into a single contra-expense line if immaterial or preferable.

Example #1: Multiple Individual Line Items

Income Statement >>> Purchase Expenses
Purchases - Gross Expense $100,000
(Less: Purchase Discounts) (Contra Expense) ($15,000)
(Less: Purchase Returns) (Contra Expense) ($10,000)
(Less: Purchase Allowances) (Contra Expense) ($5,000)
Purchases - Net Net Balance (= Expense - Contra) $70,000

Example #2: One Aggregated Line Item

Income Statement >>> Purchase Expenses [Aggregated]
Purchases - Gross Expense $100,000
(Less: Purchase Returns, Discounts and Allowances) (Contra Expense) ($5,000)
Purchases - Net Net Balance (= Expense - Contra) $95,000

Calculation Formula

The net balance of Purchase Expenses on an income statement is calculated as the difference between a company’s gross purchases and all associated contra expenses like Purchase Returns, Allowances and Discounts.

Net Purchase Expense = Gross Purchase Expense – Contra Purchase Expense

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Emilie N., FCCA, CB, MBS
Emilie N., FCCA, CB, MBS

Emilie is a Certified Accountant and Banker with Master's in Business and 15 years of experience in finance and accounting from large corporates and banks, as well as fast-growing start-ups.

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