Lesson: 42

Topic: Purchase and Sales Discounts, Purchase and Sales Allowances

Objectives:  

The primary focus of this class is the calculation of, and accounting for the following items:

• purchase discounts
• sales discounts
• purchase returns and allowances
• sales returns and allowances

Purchase Discounts: AKA Merchandise Discounts. A discount received on an amount owing for the purchase of inventory, or in some cases, supplies or utilities. The discount is offered by suppliers in exchange for early payment of an invoice, and is thus associated only with credit purchases. The discount percentage is indicated within the credit terms provided at the time of sale, and it is calculated on the total amount owing. Purchase discounts are accounted for within a contra-expense account.

Sales Discounts: A discount offered to customers on an amount owing for a sale made on account. The discount is offered in exchange for early payment of an invoice, and is thus associated only with credit sales. The discount percentage is indicated within the credit terms provided at the time of sale, and is calculated on the total amount owing. Sales discounts are accounted for within a contra-sales account.

Purchase Returns and Allowances: A reduction made to an amount owing for the credit purchase of inventory, or in some cases, supplies or utilities. The reduction is the result of a dissatisfaction in the item purchased. The item might have been returned, or the discount might be offered simply to compensate for our dissatisfaction.

Sales Returns and Allowances: A reduction made to an account receivable as a result of a customer's dissatisfaction in the item purchased. The item might have been returned, or the discount might be offered simply to compensate for our customer's dissatisfaction.

Understanding "Credit Terms"

Credit terms indicate particular legal details of a credit sale. These details indicate the due date, the interest rate to be charged on overdue balances, and any discount offered for early payment. Terms are often indicated in an abbreviated form that would be easy to type out on an old-fashioned typewriter. An example of typical credit terms would be:

In the above example:
• "2" indicates the discount percentage offered on the amount owing,
• "10" indicates the number of days (from the invoice date) one must pay within in order to receive the discount,
• "n/30" indicates the number of days within which the bill must be paid in full.

Understanding the Accounting for Discounts

Purchase Discount: In the case where we were paying an account payable to Acme Corp. for $100.00, early enough to receive a 2% discount, we would make the following entry:

Sales Discount: In the case where we are receiving payment from Jane Smith for a $100.00 account receivable, early enough to offer a 2% discount, we would make the following entry:

Understanding the Accounting for Allowances

i. Sales Allowance: In the case where we offer an allowance of $20.00 (off a $100.00 account) to Jane Smith for a slight defect in her merchandise, we would make the following entry:

ii. Receiving Payment following an Allowance: In the above case we would extend the original discount period starting from the date that we issued the credit note for the defective merchandise, we would then offer the 2% discount on the remaining $80.00 that is owing on the account. When the account is finally paid in full, we would make the following entry:

Evaluation Exercise:

The assigned problem for the class will be: 

• Exercise 2 on page 460, and
• Exercise 3 on page 460

The "Advanced Accounting Practices" strand of the BAF3M Ministry of Education Curriculum Guidelines outlines all of the following specific expectations. The expectations addressed by this lesson have been highlighted below.

• The Accounting Cycle for a Merchandising Business:
  • describe the principal accounting elements particular to a merchandising business (e.g., new accounts, cost of goods sold section, returns, discounts);
  • identify and describe the periodic and perpetual inventory systems and journalize transactions using both systems;
  • assess the effects that transactions have on the accounts and financial statements of a merchandising business;
  • record transactions in the journals and ledgers of a merchandising business;
  • prepare a trial balance and the financial statements, including a detailed cost of goods sold section, for a merchandising business;
  • record the adjusting and closing entries for a merchandising business (e.g., accruals, inventory adjustment);
  • describe the impact of year-end procedures, including adjusting and closing entries, on the financial statements of a merchandising business;
  • describe alternative accounting practices (e.g., special journals and ledgers).
• Accounting for Sales Tax:
  • describe the accounting practices particular to sales tax (e.g., accounts required, financial statement presentation);
  • record transactions related to provincial sales tax (e.g., collections, remittance);
  • record transactions related to federal sales tax (e.g., collections, remittance).
• Computer Applications in Accounting:
  • use accounting or application software to record transactions for a service business;
  • use accounting or application software to record transactions for a merchandising business;
  • use accounting or application software to prepare financial statements.

Reference:

Please read this topic (pages 444-458) in preparation for the class.