What is a Purchase Allowance?

A purchase allowance is a reduction in the list price offered by a manufacturer or distributor, in exchange for ordering a minimum quantity. This allowance may also be granted to a customer in exchange for the buyer’s retention of damaged or incorrect goods. Purchase allowances are more common when customers have formal purchasing functions; the purchasing staff can then negotiate for purchase allowances with suppliers.

Accounting for a Purchase Allowance

When a supplier grants a purchase allowance, the buyer records the amount of the allowance as a debit to accounts payable and a credit to inventory. The seller records the allowance in the sales allowances account; this is a contra revenue account that is paired with and offsets gross sales. The seller also records a reduction in its accounts receivable account via a credit memo, thereby reducing the receivable expected from the buyer.

Purchase Allowance Fraud

Fraud can occur in the granting of purchase allowances. This requires the connivance of someone within the selling organization, who is usually being paid a kickback by the buying organization. The person within the selling organization incorrectly grants a purchase allowance in exchange for a portion of the amount that the buying entity no longer needs to pay. This issue can be mitigated by having a senior person within the selling organization approve all purchase allowances that exceed a certain threshold level.