Inventory Accounting for Beginners: Costing, Valuation, and Common Entries

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Recording Inventory Purchases: Typical Journal Entries and Source Documents

Capítulo 4

Estimated reading time: 8 minutes

+ Exercise

Purchase-Related Source Documents (and What Each Proves)

Inventory purchases should be supported by a small set of documents that answer three questions: What was authorized? (purchase order), what was billed? (supplier invoice), and what was actually received? (receiving report). Together, they create an audit trail that supports the amounts and timing of your journal entries.

Purchase Order (PO)

A purchase order is a document your company sends to a supplier to authorize a purchase. It typically lists items, quantities, agreed prices, delivery terms, and shipping terms (for example, FOB shipping point or FOB destination).

Accounting impact: A PO usually does not create a journal entry by itself because it is an authorization, not a completed transaction.
What it supports: It supports internal control (approval) and helps verify that the invoice matches what was ordered.

Supplier Invoice

A supplier invoice is the supplier’s bill. It usually includes invoice date, items shipped, prices, payment terms (such as 2/10, n/30), and sometimes freight terms (whether freight is prepaid by the supplier or paid by the buyer).

Accounting impact: In many companies, the invoice triggers recording a liability (Accounts Payable) and the purchase amount (Inventory or Purchases, depending on the system).
What it supports: The amount owed, payment terms, and the basis for discounts.

Receiving Report (Receiving Document / Goods Received Note)

A receiving report is prepared when goods arrive. It records the date received, quantities received, condition, and references to the PO and shipment details.

Accounting impact: Under a perpetual system, the receiving report often supports recording Inventory when goods are received (even if the invoice arrives later). Under a periodic system, companies commonly record when the invoice is received, but the receiving report still supports that the goods were actually received.
What it supports: Existence and quantity—critical for preventing payment for goods not received.

Three-Way Match (Control Step)

Many businesses use a three-way match before recording or paying an invoice: match the PO (authorized), receiving report (received), and invoice (billed). Differences are investigated (short shipments, price differences, damaged goods, etc.).

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Typical Journal Entries: Perpetual vs. Periodic

The same business event can be recorded differently depending on the inventory system. The entries below focus on purchase-related transactions: purchases on account, returns/allowances, discounts, and freight-in.

1) Purchase of Inventory on Account

Scenario: You buy merchandise for resale from a supplier on credit.

System	Entry	What the entry is doing
Perpetual	`Dr Inventory Cr Accounts Payable`	Records inventory asset immediately and the liability to the supplier.
Periodic	`Dr Purchases (or Purchases—Merchandise) Cr Accounts Payable`	Accumulates purchases in a temporary account; inventory is updated later via end-of-period adjustments.

Step-by-step:

Confirm the purchase is authorized (PO) and received (receiving report).
Use the invoice to determine the amount to record and the payment terms.
Post to Inventory (perpetual) or Purchases (periodic), and credit Accounts Payable.

2) Purchase Returns and Allowances (Goods Returned or Price Reduction)

Scenario: You return goods to the supplier (return) or keep them but receive a credit for defects/overcharge (allowance). The supplier issues a credit memo.

System	Entry	Notes
Perpetual	`Dr Accounts Payable Cr Inventory`	Reduces the liability and reduces inventory because the goods are no longer on hand (or the cost is reduced for an allowance).
Periodic	`Dr Accounts Payable Cr Purchase Returns and Allowances`	Uses a contra-purchases account to reduce net purchases for the period.

Step-by-step:

Initiate return/allowance referencing the original PO/invoice.
Verify quantities returned (shipping/return document) and obtain supplier credit memo.
Record the credit memo: debit Accounts Payable; credit Inventory (perpetual) or Purchase Returns and Allowances (periodic).

3) Purchase Discounts (Cash Discounts for Early Payment)

Scenario: Terms are 2/10, n/30. If you pay within 10 days, you can deduct 2% from the invoice price (typically on the goods amount, not including sales tax or sometimes not including freight—company policy and invoice terms matter).

3A) Paying within the discount period

System	Entry at payment date	What changes
Perpetual	`Dr Accounts Payable (full invoice) Cr Cash (invoice less discount) Cr Inventory (discount)`	Inventory is reduced because the discount reduces the cost of inventory acquired.
Periodic	`Dr Accounts Payable (full invoice) Cr Cash (invoice less discount) Cr Purchase Discounts`	Purchase Discounts is a contra-purchases account that reduces net purchases.

Mini example: Invoice $1,000, terms 2/10, n/30. Paid within 10 days. Discount = $20. Cash paid = $980.

Perpetual: Debit A/P 1,000; Credit Cash 980; Credit Inventory 20.
Periodic: Debit A/P 1,000; Credit Cash 980; Credit Purchase Discounts 20.

3B) Paying after the discount period

If you miss the discount window, you pay the full amount.

System	Entry at payment date
Perpetual	`Dr Accounts Payable Cr Cash`
Periodic	`Dr Accounts Payable Cr Cash`

4) Freight-In (Transportation Cost to Bring Goods to Your Location)

Freight-in is generally part of the cost of acquiring inventory when the buyer pays shipping (common under FOB shipping point). The key difference is where you record it during the period.

4A) Freight-in paid in cash to the carrier

System	Entry	Key idea
Perpetual	`Dr Inventory Cr Cash (or Accounts Payable—Freight)`	Add freight to the Inventory asset immediately.
Periodic (separate account convention)	`Dr Freight-In (or Transportation-In) Cr Cash (or Accounts Payable—Freight)`	Tracks freight separately; it will be included in cost of goods available for sale through period-end calculations.
Periodic (included in Purchases convention)	`Dr Purchases Cr Cash (or Accounts Payable—Freight)`	Some companies include freight-in in Purchases instead of a separate Freight-In account.

Step-by-step:

Confirm shipping terms on the PO/invoice (who pays freight).
Use the carrier bill (or supplier invoice if freight is billed to you) to determine the freight amount.
Record freight-in to Inventory (perpetual) or to Freight-In/Purchases (periodic, depending on convention).

Putting It Together: A Short Transaction Set (Worked Example)

Assume: You purchase goods on account for $5,000, terms 2/10, n/30. You pay freight-in of $200 cash. Later you return $500 of goods. Then you pay the remaining balance within the discount period (discount applies to goods kept).

Perpetual system entries

1) Purchase on account
Dr Inventory 5,000
    Cr Accounts Payable 5,000

2) Freight-in paid
Dr Inventory 200
    Cr Cash 200

3) Return of goods
Dr Accounts Payable 500
    Cr Inventory 500

4) Payment within discount period
Amount subject to discount = 5,000 - 500 = 4,500
Discount = 2% × 4,500 = 90
Cash paid = 4,500 - 90 = 4,410
Dr Accounts Payable 4,500
    Cr Cash 4,410
    Cr Inventory 90

Periodic system entries (Freight-In separate)

1) Purchase on account
Dr Purchases 5,000
    Cr Accounts Payable 5,000

2) Freight-in paid
Dr Freight-In 200
    Cr Cash 200

3) Return of goods
Dr Accounts Payable 500
    Cr Purchase Returns and Allowances 500

4) Payment within discount period
Discount = 2% × (5,000 - 500) = 90
Cash paid = 4,410
Dr Accounts Payable 4,500
    Cr Cash 4,410
    Cr Purchase Discounts 90

Common Posting Mistakes (and How the Documents Help Prevent Them)

Recording a purchase from a PO alone: The PO is authorization, not proof of receipt or billing. Wait for receiving report/invoice per company policy.
Paying an invoice for goods not received: The receiving report prevents this; use three-way match.
Recording freight-in as an expense: Freight-in is part of inventory cost (capitalized) in perpetual; in periodic it is accumulated in Freight-In or Purchases (not a selling expense like freight-out).
Taking a discount on the wrong base: Discounts usually apply to the merchandise amount kept (after returns/allowances), not to amounts returned and often not to taxes; check invoice terms.
Using the wrong account under the wrong system: Perpetual uses Inventory for purchases/returns/discounts; periodic uses Purchases, Purchase Returns and Allowances, Purchase Discounts, and Freight-In (or Purchases).

Quick Drills: Choose the Correct Debit/Credit and Account

Instructions: For each transaction, choose the correct entry. Assume all purchases are on account unless stated otherwise. Answers are shown immediately after each drill so you can self-check.

Drill 1: Purchase on account

Transaction: Bought merchandise on account for $2,400. (a) Perpetual system. (b) Periodic system.

Your choice (a): Debit ______; Credit ______.
Your choice (b): Debit ______; Credit ______.

Answer:

(a) Dr Inventory 2,400; Cr Accounts Payable 2,400
(b) Dr Purchases 2,400; Cr Accounts Payable 2,400

Drill 2: Return to supplier

Transaction: Returned $300 of merchandise to the supplier; supplier issued a credit memo. (a) Perpetual. (b) Periodic.

Your choice (a): Debit ______; Credit ______.
Your choice (b): Debit ______; Credit ______.

Answer:

(a) Dr Accounts Payable 300; Cr Inventory 300
(b) Dr Accounts Payable 300; Cr Purchase Returns and Allowances 300

Drill 3: Discount taken on payment

Transaction: Invoice for $1,500, terms 2/10, n/30. Paid within discount period. (a) Perpetual. (b) Periodic.

Your choice: Discount = ______; Cash paid = ______.
Your entry (a): Dr ______; Cr ______; Cr ______.
Your entry (b): Dr ______; Cr ______; Cr ______.

Answer: Discount = 2% × 1,500 = 30; Cash paid = 1,470.

(a) Dr Accounts Payable 1,500; Cr Cash 1,470; Cr Inventory 30
(b) Dr Accounts Payable 1,500; Cr Cash 1,470; Cr Purchase Discounts 30

Drill 4: Freight-in paid to carrier

Transaction: Paid $120 cash for inbound freight on merchandise purchased. (a) Perpetual. (b) Periodic (Freight-In separate). (c) Periodic (Freight included in Purchases).

Your choice (a): Dr ______; Cr ______.
Your choice (b): Dr ______; Cr ______.
Your choice (c): Dr ______; Cr ______.

Answer:

(a) Dr Inventory 120; Cr Cash 120
(b) Dr Freight-In 120; Cr Cash 120
(c) Dr Purchases 120; Cr Cash 120

Drill 5: Mixed transaction (returns before payment)

Transaction: Purchased $4,000 on account, terms 1/10, n/30. Returned $600 of goods. Paid the remainder within the discount period. (a) Perpetual payment entry only. (b) Periodic payment entry only.

Your choice: Amount eligible for discount = ______; Discount = ______; Cash paid = ______.
Your entry (a): Dr ______; Cr ______; Cr ______.
Your entry (b): Dr ______; Cr ______; Cr ______.

Answer: Eligible amount = 4,000 − 600 = 3,400; Discount = 1% × 3,400 = 34; Cash paid = 3,366.

(a) Dr Accounts Payable 3,400; Cr Cash 3,366; Cr Inventory 34
(b) Dr Accounts Payable 3,400; Cr Cash 3,366; Cr Purchase Discounts 34

Now answer the exercise about the content:

Which set of source documents is matched in a three-way match to help ensure an invoice is authorized, the goods were received, and the supplier billed the correct amount?

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A three-way match compares the purchase order (authorized), receiving report (received), and supplier invoice (billed) to confirm accuracy before recording or paying.