Question

When goods are purchased for resale by a company using a periodic inventory system: a. purchases on account are debited to Inventory. b. purchases on account are debited to Purchases. c. purchase returns are debited to Purchase Returns and Allowances. d. freight costs are debited to Purchases.

Short answer

b. purchases on account are debited to Purchases.

Step-by-step solution

Understanding the Periodic Inventory System

In the periodic inventory system, the company does not keep continuous track of inventory. Instead, inventory is updated at the end of the period. Purchase transactions are recorded in temporary accounts, such as "Purchases" or "Purchase Returns and Allowances," rather than affecting the "Inventory" account directly.

Analyze Each Option

- **Option a**: In a periodic system, purchases on account are not directly debited to Inventory, so this is not correct. - **Option b**: The correct practice is to debit the Purchases account when goods are purchased on account in a periodic inventory system. This is correct according to accounting practice. - **Option c**: Returns should be debited to the Purchase Returns and Allowances account, not to purchases. This is incorrect. - **Option d**: Freight costs, also known as freight-in, are typically added to the cost of purchases but not directly debited to "Purchases." This is generally incorrect.

Choose the Correct Option

Based on the above analysis, Option b is the correct choice because, in a periodic inventory system, when goods are purchased on account, purchases are recorded in the Purchases account, reflecting the current accounting practices.

Key concepts

Purchases account

The Purchases account is a fundamental component of the periodic inventory system. This system does not track inventory continuously but updates inventory balances periodically.
Instead of affecting the Inventory account, purchases made during the period are debited to the Purchases account. This approach allows a business to record all acquisition costs in a dedicated account, providing a clear picture of the total purchases made throughout the period.

• In a periodic inventory system, when a company buys goods for resale, it debits the Purchases account. This is different from a perpetual inventory system, where purchases would directly affect the Inventory account.
• The Purchases account is considered a temporary account. It accumulates all purchases within a given accounting period, and at the end of the period, its balance is transferred to the inventory balance on the income statement.

Using the Purchases account streamlines the recording of goods bought on account, simplifying the tracking of purchasing activity across accounting periods.

Purchase Returns and Allowances

In the world of accounting, Purchase Returns and Allowances play a critical role in adjusting the Purchases account during a period. When a company returns goods or negotiates a discount due to defective products, these transactions are recorded separately.
Instead of affecting the Purchases account balance, they are entered into a distinct account—'Purchase Returns and Allowances.'

• This account records the value of goods returned to suppliers or the allowances granted, thus reflecting reductions to the total purchasing expenses incurred by the business.
• Keeping this account separate helps businesses accurately report purchase-related returns or concessions, providing clarity in financial statements without overstating the purchase figures.

By using the Purchase Returns and Allowances account, companies can better manage their expenses and maintain more accurate records of their purchasing activities, critical for financial analysis and inventory planning.

Accounting practices

Understanding and applying correct accounting practices is crucial for accurate financial reporting and operational efficiency. These practices become particularly important in systems like the periodic inventory system, which relies heavily on specific accounts to record transactions.
Generally accepted accounting principles (GAAP) provide guidelines to ensure consistency and transparency in financial reporting.

• Debiting the Purchases account rather than Inventory is a reflection of these principles, capturing all purchasing activities separately from inventory changes.
• Similarly, separating Purchase Returns and Allowances from Purchases aligns with GAAP standards. It ensures that purchase figures do not overstate expenses, helping to maintain the integrity of financial data.

These accounting practices help companies not only remain compliant with regulatory standards but also provide clearer insights into their purchasing habits, costs, and financial health, leading to better decision-making processes.