A company that uses the perpetual inventory method purchases inventory of $1,000 on account with terms of 2/10, n/30. Defective inventory of $200 is returned 2 days later and the accounts are appropriately adjusted. If the company paid the vendor within 10 days, which of the following entries would be made to record the payment?

A. $800 debit to Accounts payable, a $16 credit to Inventory and a $784 credit to Cash.

B. $784 debit to Accounts payable, a $16 debit to inventory and an $800 credit to Cash.

C. $800 debit to Accounts payable, and an $800 credit to Cash.

D. $16 debit to Inventory, an $800 debit to Accounts payable and an $816 credit to Cash.

(If you could expound upon how you arrived at the solution; that would be much appreciated!)

First you need to know what the original journal entry was. It was a Debit to Inventory and a Credit to Accounts Payable for 1,000

Now you need to know what the return of inventory journal entry was. It was a Debit to Accounts Payable and a Credit to Inventory for 200.

Now we know that your inventory balance is 800 (1,000 - 200) and your Accounts Payable balance is 800 (1,000 - 200).

Now it is time to solve the problem. You are paying your bill within the discount period, which means you are paying less that what you owe. Also when you are paying a vendor that you owe money to the accounts that will be affected is accounts payable and Cash.

So now you have to figure out how much of the 800 bill you are actually going to pay. So you start with 800 times the percentage of the discount of 2% equals the amount of discount.

So 800 times 2% equals 16, which means that 800 minus 16 is the amount you are actually paying on your account.

Now your journal entry to record the payment will be:
Debit Accounts Payable for 800(the total owed to the vendor)
Credit Cash for 784 (the amount actually paid to the vendor) and since your debits do not equal your credits you have to account for difference of 16 to a credit entry. From your choices your only option is a $16 credit to inventory because your bill was for $800 and you only paid 784.

I truly appreciate your feedback. However, I am dumbfounded on where the 2% was derived from? Furthermore, what does "with terms of 2/10, n/30" mean?

2/10, n/30 is your discount term. 2 means the percentage of discount, which is 2%. 10 means the number of days you have to get the discount. So you have 10 days from the date of purchase to receive the 2% discount. After 10 days you lose the discount. n/30 means that you have 30 days from the date of purchase to pay for your purchase.

Thanks, pready!