Some of the transactions of Torres Company during August are listed below. Torres uses the periodic inventory method.

August 10 Purchased merchandise on account, \(12,000, terms 2/10, n/30.

13 Returned part of the purchase of August 10, \)1,200, and received

credit on account.

15 Purchased merchandise on account, \(16,000, terms 1/10, n/60.

25 Purchased merchandise on account, \)20,000, terms 2/10, n/30.

28 Paid invo

ice of August 15 in full.

Instructions

(a) Assuming that purchases are recorded at gross amounts and that discounts are to be recorded when taken:

(1) Prepare general journal entries to record the transactions.

(2) Describe how the various items would be shown in the financial statements.

(b) Assuming that purchases are recorded at net amounts and that discounts lost are treated as financial expenses:

(1) Prepare general journal entries to enter the transactions.

(2) Prepare the adjusting entry necessary on August 31 if financial statements are to be prepared at that time.

(3) Describe how the various items would be shown in the financial statements.

(c) Which of the two methods do you prefer and why?

Step by step solution

01

Inventory recording at gross method

1) Journal entries

Date	Description	Debit	Credit
Aug 10	Purchase A/c	$12,000
	Accounts Payable		$12,000
	Being goods purchased on account
Aug 13	Accounts Payable	$1,200
	Purchase return and allowances		$1,200
	Being goods return to vendor
Aug 15	Purchase A/c	$16,000
	Accounts Payable		$16,000
	Being goods purchased on account
Aug 25	Purchase A/c	$20,000
	Accounts Payable		$20,000
	Being goods purchased on account
Aug 28	Accounts Payable	$16,000
	Cash		$16,000
	Being payment made to the supplier

2) Treatment of various items

In the financial statements, mainly three accounts are reported – Purchase, Purchase return and allowances, and accounts payable.

In the income statement, net purchases are shown by subtracting the purchase return and allowances from the total gross purchase value.

In the balance sheet, the total accounts payable balance are shown on the liability side.

02

Inventory recording at net method

1) Journal entries

Date	Description	Debit	Credit
Aug 10	Purchase A/c	$11,760
	Accounts Payable		$11,760
	Being goods purchased on account
Aug 13	Accounts Payable	$1,176
	Purchase discount lost	$24
	Purchase return and allowances		$1,200
	Being goods return to supplier and discount lost
Aug 15	Purchase A/c	$15,840
	Accounts Payable		$15,840
	Being goods purchased on account
Aug 25	Purchase A/c	$19,800
	Accounts Payable		$19,800
	Being goods purchased on account
Aug 28	Accounts Payable	$15,840
	Purchase discount lost	$160
	Cash		$16,000
	Being payment made to supplier and discount lost

2) Adjusting entry

Date	Description	Debit	Credit
Aug 10	Profit & loss A/c	$,216
	Purchase discount lost		$216
	Being discount lost on Aug 10 purchase

3) Treatment of various items

In the financial statements, four accounts would be reported – Purchase, Purchase return and allowances, accounts payable, and purchase discount lost.

In the income statement, the total purchase value will show the net purchase amount and the net purchase value willbe after the deduction of purchase return and allowances. Purchase discount lost is reported as an expense.

In the balance sheet, the total accounts payable balance will be shown on the liability side.

03

Preferred method

The preferred method for recording purchases is the gross method. Some of the reasons for this preference are –

a) It is the simpler method

b) Net method is reluctant as discount lost has to be reported

c) It represents the correct purchase value at any time.

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