Download Cash discount

Chapter 14: control accounts
Learning outcomes:
Prepare accounting entries for
discounts
Understand control account
Reconcile the control account
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Discounts
There two types of discounts.
• Trade discount
• Cash discount, or settlement discount
Trade discount is a reduction in the cost of goods
resulting from the nature of the trading transaction. It
usually results from buying goods in bulk.
Cash discount is a reduction in the amount payable to
the supplier in return for immediate payment rather than
credit.
Settlement discount is similar to cash discount. It is a
discount on the price of the goods purchased for credit
customers who pay their debts promptly.
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Accounting for trade discount
Trade discount is accounted for as follows.
a) Trade discount received is deducted from the gross
cost of purchases. Purchases are recorded at the net
invoiced amount which is after deducting the discount.
b) Trade discount allowed is deducted from the gross
sales price, so that sales are recorded at net invoiced
value which is after deducting the discount.
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Cash discounts and settlement discounts received
Fast forward
Unlike trade discount, cash and settlement
discounts are not deducted from the invoice price of
the goods. The invoice is processed in the normal
way and any discount received when payment is
made is credited to a ‘discounts received’ account.
When a business is given the opportunity to take
advantage of a cash discount or a settlement
discount for prompt payment, the decision as to
whether or not to take the discount is a matter of
financing policy, not trading policy, and the benefit
is at the time of payment.
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Example :cash discounts received
A buys goods from B, on the understanding that A will be allowed a period of
credit before having to pay for the goods. The terms of the transaction are as
follows.
• Date of sale: 1 July 20X6
• Credit period allowed: 30 days
• Invoice price of the goods: $2,000
• Discount offered: 4% for prompt payment
A has a choice between holding on to his money for 30 days and then paying
the full $2,000, or paying $2,000 less 4%($1,920) now. This is a financing
decision whether it is worthwhile for A to save $80 by paying its debts sooner.
If A decides to take the cash account, he will pay $1,920, instead of the invoice
amount $2,000. The cash discount received will be accounted for in the books
of A as follows.
(a) In the trading account, the cost of purchases will be at the invoice price
of $2,000
(b) In the income statement, the cash discount received is shown as through
it were income received.
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Example :cash discounts received
We would have:
Cost of purchase from B by A (trading account)
Discount received (income in the I/S)
Net cost
$2,000
(80)
1,920
Settlement discounts received are accounted for in exactly the same way as
cash discounts received.
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Cash discounts and settlement discounts allowed
The same principle is applied in accounting for
discounts or settlement discounts allowed to
customers. Goods are sold and the offer of a discount
is a matter of financing policy for the business, and
not trading policy.
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Example: settlement discount received
X sells goods to Y at a price of $5,000. Y is allowed 60 days’ credit before
payment, but is also offered a settlement discount of 2% for payment within
10 days of the invoice date. X issues an invoice to Y for $5,000. X has no
idea whether or not Y will take advantage of the discount. In trading terms Y
is a debtor for $5,000.
If Y subsequently decides to take the discount, he will pay $5,000 less 2%
ten days later. The discount allowed will be accounted for by X as follows.
(a) In the trading account, sales are valued at their full invoice price,
$5,000.
(b) In the income and expenditure account, the discount allowed will
be shown as an expense.
We would have:
Sales (trading account)
$5,000
Discount allowed (I&E)
(100)
Net sales
4,900
Cash discounts allowed are accounted for in exactly the same way as
settlement discounts allowed.
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Control accounts
A control account is an account in the nominal ledger in
which a record is kept of the total value of a number of similar but
individual items.
The two most important control accounts:
•
A receivables control account is an account in which
records are kept of transactions involving all
receivables in total.
•
A payables control account is an account in which
records are kept of transactions involving all payables
in total.
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Why control accounts are kept?

They provide a check on the accuracy of entries, made in the
sales and purchases ledgers.

The control account also assist in the location of errors.

Where there is separation of book-keepings duties, the control
account provides an internal check.

Control accounts provide the total receivables and payables
balances more quickly for producing a trial balance or statement
of financial position.
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Reconciling the control account
The balance on the control account may not agree with the sum of balances
extracted, for one or more of the following reasons.
 An incorrect amount may be posted to the control account because of a
miscast of the book of prime entry.
 A transposition error may occur in posting an individual’s balance.
 A transaction may be recorded in the control account and not in the
memorandum ledger, or vice versa.
 The sum of balances extracted from the memorandum ledger may be
incorrectly extracted or miscast.
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Example: agreeing control account balances with the sales and purchase
ledgers
The balance on the receivables control account is $15,091. The total of the list
of balances taken from the sales ledger is $15,320. It is discovered that:
a) $10 received from a receivables and put in the petty cash it was correctly
recorded in his personal account but excluded from the nominal ledger.
b) The sales day book for March was undercast by $100.
c) When posting an invoice for $95 to a customers account it was recorded as
$59 by mistake.
d) A credit balance of $60 in the sales ledger was treated as a debit balance
when adding up the list of balances.
e) The list of balances has been overcast by $90.
f) The returns inwards for June totaling $35 have been correctly recorded in
the sales ledger, but no entries have been made in the nominal ledger.
Required
Show the adjustments necessary to the list of balances and to the receivables
control account.
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LO 3
Solution: agreeing control account balances with the sales and purchase
ledgers
Sales ledger total
Original total extracted
Add difference arising from transposition
error ($95 written as $59)
$15,320
36
15,356
Less
Credit balance of $60 extracted as a debit balance ($60*2) $120
Overcast of list of balances
90
210
15,146
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LO 3
Solution: agreeing control account balances with the sales and purchase
ledgers
RECEIVABLES CONTROL
Balance before adjustments
Undercast of total invoices
issued in sales day book
Balance b/d
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$15,091 Petty cash-posting omitted
Returns inwards-individual
Posting omitted from control
account
Balance c/d (now in agreement
With the corrected total of
100 Individual balances in (a))
15,191
15,146
$10
35
15,146
15,191
LO 3