In merchandise accounting, how is the purchase returns and allowances account classified?

Introduction / Context:
In merchandising businesses, the purchases account records the cost of goods bought for resale. Sometimes goods are returned to suppliers due to damage, quality issues or other reasons, or the supplier grants allowances for price reductions. These events are recorded in a separate account called purchase returns and allowances. This question asks you to classify that account correctly and to understand its effect on the total cost of purchases reported in the financial statements.

Given Data / Assumptions:
- The focus is on the purchase returns and allowances account. - The business uses a periodic inventory system with a purchases account. - Purchase returns and allowances record merchandise sent back or price reductions granted. - We must decide whether this account is a contra account, expense, liability or revenue.

Concept / Approach:
A contra account is used to reduce the balance of a related account and is presented in the financial statements either as a deduction or on the opposite side in the ledger. In merchandising, purchase returns and allowances is a contra purchases account. When goods are returned or allowances are granted, the business debits accounts payable or cash and credits purchase returns and allowances. At the end of the period, the balance of this account is deducted from total purchases, reducing the net purchases figure used in the cost of goods sold calculation. It is not a liability or revenue account; rather, it offsets the purchases account to show the net cost of merchandise actually retained by the business.

Step-by-Step Solution:
Step 1: Remember that purchases record the gross cost of merchandise acquired. Step 2: When merchandise is returned or an allowance is granted, the appropriate accounting treatment is to reduce the effective cost of purchases. Step 3: To keep track of these reductions separately, a contra account called purchase returns and allowances is used. Step 4: At period end, this contra account is subtracted from the purchases account to arrive at net purchases in the cost of goods sold calculation. Step 5: Therefore, the correct classification is that purchase returns and allowances is a contra account to purchases.

Verification / Alternative check:
In typical income statement formats for merchandising firms, you will often see lines such as purchases, less purchase returns and allowances, less purchase discounts, equal net purchases. This presentation makes sense only if purchase returns and allowances is a contra account that reduces purchases. Textbook journal entries also show credits to purchase returns and allowances when goods are returned, indicating that it has a normal credit balance opposite to the debit balance of the purchases account. This supports the conclusion that it is a contra account rather than an independent expense or liability.

Why Other Options Are Wrong:
Normal expense account: While purchases itself is treated as a cost account, purchase returns and allowances reduces that cost rather than adding to it. Liability account: Returns and allowances do not create new obligations; instead, they reduce existing obligations or increase cash. Revenue account: These entries do not arise from selling goods to customers; they relate to buying goods from suppliers.

Common Pitfalls:
Students sometimes treat all accounts with the word expense or cost as similar, forgetting that some accounts serve to offset others. Confusing purchase returns and allowances with sales returns and allowances is another common error; both are contra accounts but they affect different sides of the trading activity. For exam questions, watch for the word returns and allowances and relate it to either purchases or sales to determine whether it is a contra purchases or contra sales account.

Final Answer:
The correct option is As a contra account that reduces total purchases of merchandise, because purchase returns and allowances is used to offset the purchases account and show the net cost of goods acquired for resale.