How do purchase discounts and purchase returns affect the cost of inventory?

• A. Discounts reduce cost if taken; returns reduce cost of purchases; both reduce inventory cost or COGS depending on method.
• B. They never affect the cost; only affect revenue.
• C. Discounts reduce revenue; returns increase inventory at cost.
• D. Discounts increase COGS; returns have no effect.

Answer: (A)

Purchase discounts and returns change the cost basis of inventory. When you take a purchase discount, you pay less for the goods, so the cost recorded for the inventory is reduced by that discount. When you return goods, the purchase cost is reduced by the value of the returns. In either case, these reductions lower the amount tied up in inventory and, when the inventory is sold, lower the cost of goods sold. Whether the reduction appears in the Inventory account or in Purchases (and ultimately COGS) depends on whether you're using a perpetual or periodic system and whether you apply the gross or net method, but the outcome is the same: these items reduce the recorded cost of inventory and, thus, COGS when the goods are sold.