 When recording the journal entries for the purchase of inventory, an invoice has all of the pertinent information, including the total amount purchased, the shipping terms, and the payment terms. So let's learn how to record inventory transactions for a perpetual buyer using the invoice. Championship vinyl, a perpetual inventory tracker, purchases $3,800 of vinyl records on account. So we would debit inventory and credit accounts payable for $3,800. That's pretty straightforward, so let's complicate it a bit by introducing the shipping terms. The shipping terms are negotiated between buyers and sellers. The two most common terms are FOB shipping point and FOB destination. In addition to these terms being important for accounting purposes, they are also legal terms involved in contracts that require delivery. FOB means free on board. For FOB shipping point, a seller delivers the goods to a common carrier, like UPS or FedEx, at the seller's shipping dock. Inventory transfers to the buyer at this point and the buyer pays the freight cost directly to the common carrier. Finally, the seller records the revenue at this point. For FOB destination, a seller delivers goods to a common carrier, again like UPS or FedEx, at the seller's shipping dock. However, inventory doesn't transfer to the buyer until it is received by the buyer. In this case, the seller pays the freight cost directly to the common carrier. The seller does not record the revenue until it is received by the buyer. So in our case, the terms are FOB shipping point. So who pays the freight? That's right, it's championship vinyl, the buyer. The journal entry to record the payment of $150 of freight charges is a debit to inventory and a credit to cash. Sometimes our students are confused as to why inventory is increasing when we pay for freight. In this case, the quantity of records isn't increasing, but the cost of the records is increasing because of the shipping costs. Let's look at this example of a tie I recently bought. By definition, all the costs incurred to get an asset ready for its intended purpose are included in the cost of the asset. Now that's a definition thing you might want to keep track of. Those costs would include the cost to ship the tie to me as well as the taxes I have to pay. So in this case, how much did the tie cost me? Was it $59.99? The cost of the tie? Or was it $69.10? The cost of the tie plus shipping plus sales tax. Well, according to my credit card statement, it was $69.10. And that's the amount that I would record as the cost of the tie. So the cost of our records, back in our example, should include the $3,800 that we paid for the records. But also the $150 of shipping and that's why we debited inventory. A buyer may be dissatisfied with a purchase because the goods are damaged or defective or of inferior quality or just the wrong ones were sent. Most of you are probably familiar with the concept of a purchase return. When this happens, the buyer sends the goods back for a refund. In the case of a business-to-business sale, often only some of the merchandise is returned and the amount owed is just reduced. You're probably less familiar with a purchase allowance. When an allowance is granted by a seller to a buyer, the goods are not physically returned. This is fairly common with damaged goods. The seller doesn't want them back, but the buyer doesn't want to pay full price for damaged goods. So the seller offers an allowance, which is a deduction in the cost of the inventory, rather than a reduction in the amount of physical inventory. Have any of you ever shopped at a scratch and dent section of a furniture store? This section is a result of purchase allowances. The cost of goods was reduced because they were damaged or some reason that caused that to happen. And therefore the price to the customer has been reduced in order to sell the goods. In this example, let's assume that Taylor Swift records were shipped in correctly and Championship Vinyl returns them. Basically, this is just a reversal of our purchase journal entry. We debit accounts payable and credit inventory for the amount of the records, which was $500. Since we are returning the goods, we are reducing the inventory with the credit and the amount we owe is also decreasing. This would be the same journal entry if this were just an allowance. Purchased discounts are credit terms that may permit buyers to claim a cash discount for prompt payment. The benefit to the buyer is obvious. They get to pay less for their goods. However, there are important benefits to the seller as well. You recall learning about the operating cycle. When buyers take advantage of payment discounts, this accelerates the operating cycle and the seller collects the cash quicker and that's a big benefit to them. Here you can see some common types of payment terms. We read these like this. 210 net 30. 315 net 45. 17 net 15. So 210 net 30 means a 2% discount if the payment is made within 10 days. Otherwise, the net amount is due in 30 days. So let's assume Championship Vinyl pays the invoice on January 12th within the 10-day discount period. How much do they have to pay? Well, let's answer that question by figuring out how much they owe. To do this, I like to look at the T account for accounts payable. Initially, we credited the account for the purchase amount of $3,800. However, we also debited this account when we returned the Taylor Swift records. So the balance is $3,300. I can't tell you how many times students miss the return so make sure to reference the T account so that you end up getting the right amount that is owed. So here we owe $3,300. But we don't have to pay that much because we're paying within the discount period. So a 2% reduction is a $66 discount, meaning we only have to pay $3,234. Notice, though, that accounts payable needs to be debited for $3,300. If we were to debit the cash amount for accounts payable, then our records would show that we still owe $66 when we do not. So this journal entry here is out of balance. We need a credit of $66 to make it balance. Here you can see that that credit is to the inventory account. Now, again, it's not because physical units were reduced, but the cost of inventory was reduced because we took the discount and that lowered our overall cost. So are discounts worth the hassle? In our example, the discount saved us $66 by paying 20 days earlier. Had we invested the $3,300 at 5% annually for the 20 days, we would have earned about $9 in interest. So taking the discount saved us an additional $57. Another way to think about discounts is the following. It costs us 2% to keep our cash for about an extra 20 days. There are approximately 18 20-day periods in the year. So 2 times 18 is the equivalent of 36% interest, which is high by any standards, including the Sopranos. Because of this, most companies will take the payment discount. In fact, most companies will borrow money from a bank if they're short on cash just to take the discount because the bank terms are likely better than 36% interest.