What is a purchase return and allowance?

• A. Increase in Purchases; Increases Accounts Payable.
• B. Reduction in Purchases; Reduces Accounts Payable and Inventory.
• C. No effect on Inventory; Increases Revenue.
• D. Reduction in Revenue; Increases Cash.

Answer: (B)

A purchase return and allowance works to undo part of what was originally recorded for a purchase. When you return goods or receive an allowance, you reduce the cost you recorded for purchases, you decrease what you owe the supplier, and you reduce the inventory asset if the items are being sent back and no longer on hand. In a perpetual inventory system, that means the inventory balance drops as the items are returned, and accounts payable drops because the liability to the supplier is settled.

So the effect is a reduction in purchases (or a contra-purchases entry), a lower accounts payable balance, and a lower inventory balance in the case of a return. If a company only gets an allowance while keeping the goods, the inventory impact may be different, but the overarching idea is that a purchase return or allowance lowers the cost recorded and reduces the liability.