Cost of Goods Purchased

Cost of goods purchased is the net cost a merchandiser incurs buying inventory for resale during a particular period, calculated as gross purchases minus purchase returns and allowances and purchase discounts, plus freight-in, the shipping cost the buyer pays to bring the goods in. It is a building block used specifically to calculate cost of goods available for sale under the periodic inventory system.

Gross purchases represent the full invoiced cost of merchandise bought during the period before any adjustments. Purchase returns reduce that figure when merchandise is sent back to the supplier, purchase allowances reduce it when the supplier grants a price reduction without requiring the goods to be returned, often because of minor defects or shipping damage, and purchase discounts reduce it further when the buyer pays within a supplier's early-payment discount window. Freight-in is then added back, since the cost of getting the merchandise delivered is considered part of what it actually cost to acquire the inventory, not a separate operating expense.

Freight-in, the cost the buyer pays to receive purchased goods, is added into cost of goods purchased because it is a cost of acquiring inventory and is therefore inventoriable, eventually flowing into cost of goods sold once the related goods are sold. Freight-out, the cost a seller pays to deliver goods to its own customers, is treated completely differently: it is an ordinary selling expense recorded directly on the income statement, not added to the cost of the inventory being shipped out, since by that point the sale has already occurred and the inventory cost has already been determined.

Under the periodic inventory system, purchases, purchase returns and allowances, and purchase discounts are each tracked in their own temporary accounts throughout the period and combined only at period end to arrive at net cost of goods purchased. Under the perpetual inventory system, by contrast, each purchase, return, allowance, and discount is recorded directly against the inventory account as it occurs, so there is no separate running total called cost of goods purchased; the inventory account's balance is simply kept continuously current instead.

Even though most modern accounting software effectively runs a perpetual system behind the scenes, understanding how cost of goods purchased is built remains useful for anyone auditing a company's purchasing records, analyzing supplier relationships and payment-term discipline, or reconciling a periodic-style physical inventory count against what the books show, since each of the individual components — gross purchases, returns, allowances, discounts, and freight-in — represents a real, separately trackable aspect of how efficiently a company manages its buying process.

A retailer records gross purchases of $220,000 during a period, along with $5,000 of purchase returns, $2,000 of purchase allowances, and $3,000 of purchase discounts taken for paying suppliers early, plus $10,000 of freight-in on incoming shipments. Cost of goods purchased for the period would be $220,000 minus $5,000 minus $2,000 minus $3,000, plus $10,000, for a net figure of $220,000, which then feeds directly into the cost of goods available for sale calculation for the period.