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Chapter 14: control accounts Learning outcomes: Prepare accounting entries for discounts Understand control account Reconcile the control account BPP LEARNING MEDIA TITLE HERE 00 MONTH 0000 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. BPP LEARNING MEDIA TITLE HERE 00 MONTH 0000 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. BPP LEARNING MEDIA TITLE HERE 00 MONTH 0000 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. BPP LEARNING MEDIA TITLE HERE 00 MONTH 0000 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. BPP LEARNING MEDIA TITLE HERE 00 MONTH 0000 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. BPP LEARNING MEDIA TITLE HERE 00 MONTH 0000 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. BPP LEARNING MEDIA TITLE HERE 00 MONTH 0000 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. BPP LEARNING MEDIA TITLE HERE 00 MONTH 0000 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. BPP LEARNING MEDIA 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. BPP LEARNING MEDIA 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. BPP LEARNING MEDIA LO 3 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. BPP LEARNING MEDIA 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 BPP LEARNING MEDIA 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 BPP LEARNING MEDIA $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