Question

Please explain about Purchases Discounts and Purchases Returns and Allowances. Please indicate the purpose of these accounts. Do they appear on the Financial Statements?

2. Please explain about Sales Discounts. Why are they necessary? Does this account appear on the Financial Statements?

3. How are sales to customers using credit cards recorded?

4. Please create an example of an Income Statement for a merchandising business.

Answer 1

Answer:

1. Discounts

For the purpose of accounting, discounts are :-

a) Trade Discount : Trade discount is normally received or allowed on bulk purchase.We do not have to put any journal entry in the books of accounts for trade discount. When we receive or allow any trade discount while purchasing or selling goods, we simply deduct the amount of trade discount and balance amount is recorded.

Suppose, Mr.X purchased goods worth $10000 and received a trade discount of 10% on it. Then, in the books of account of Mr.X, we will record $(10000 - 10% of 10000) = $9000 as purchase i.e. we will debit the purchase account by $9000 and credit the cash account (if purchased in cash) or respective creditor account (if purchased in credit).We will give a narration, where we have to mention the details of trade discount i.e. the rate of trade discount and the amount on which such discount is received.

The journal entry should be :

Purchase Account Dr. $9000

To Cash / Creditor Account $9000

(Being goods purchased in cash/credit and received a trade discount of 10% on $10000.)

Trade Discount do not appear in the financial statements. We do not create any ledger for this discount, nor we pass any journal entry for such amount of discount, so the question of appearing in the financial statements do not appear.

However, if in question, it is not mentioned whether it is a trade discount or cash discount, we will always assume it to be a cash discount.

b) Cash Discount : Cash discount is generally given so that the purchaser makes payment early for the sake of receiving a discount. It is allowed for prompt payment of dues. It is recorded in the books of account by creating a separate ledger. This discount is received or allowed when payment is made or received. If trade discount is also received or allowed along with cash discount, then cash discount is calculated after deducting trade discount from invoice price i.e. cash discount is calculated on the net amount.

Suppose, Mr.Y purchased goods worth $5000 in cash and received a cash discount of 5%. Then, we have to debit Purchase Account by $5000 and credit Cash Account by $4750 and Discount Received Account by $250.

The journal entry should be :

Purchase Account Dr. $5000

To Cash Account $4750

To Discount Received $250

(Being goods purchased in cash and discount received @ 5%.)

Now suppose, a problem appears where we are given both trade discount and cash discount.
Example : Mr. X purchased goods worth $50000 and received a trade discount of 10% and cash discount of 5%.

Then entry should be :

Purchase Account Dr. $45000

To Cash Account $42750

To Discount Received $2250

(Being goods purchased in cash and received a trade discount of 10% and cash discount of 5%.)

Cash Discounts appears in th Financial Statements. If cash discount is allowed, then it will appear as Discount Allowed under INDIRECT EXPENSES. If cash discount is received, then it will appear as Discount Received under INDIRECT INCOMES.

Purchase Returns

Purchase Returns means goods that we had purchased earlier, but now returning it to the seller. We normally return goods purchased when the goods received are different from those that we had ordered, or when goods are damaged, or any other reasons as may be specified.

Now, when we return any goods, purchased earlier, then the amount of goods gets reduced and thus we have to pass journal entry in the books of account. We do not credit Purchase Account, so for recording this type of issues, we create a separate ledger account named "Purchase Return Account" or "Return Outwards Account". When goods are returned to the seller, then we credit Purchase Return Account by the amount of goods returned and debit the respective creditor.

Suppose, Mr.X returns goods, purchased earlier, worth $1000 to Mr. Y.

The journal entry should be :

Mr.Y Account (Creditor) Dr. $1000

To Purchase Returns Account $1000

(Being goods returned.)

2. Sales Discounts

Sales Discounts means discount that we allow while selling goods. These discounts are same as discussed above.
While purchasing, we receive discount and while selling, we allow discount.

Trade Discount : We do not record the amount of trade discount while selling goods too. We simply deduct the amount of trade discount and record the balance amount as sales.This is same as dicussed above.

Suppose, Mr.X sells goods worth $10000 and allowed a trade discount of 10% on it. Then, in the books of account of Mr.X, we will record the $(10000 - 10% of 10000) = $9000 as sales i.e. we will credit the sales account by $9000 and debit the cash account (if sold in cash) or respective debtor account (if sold in credit).We will give a narration, where we have to mention the details of trade discount i.e. the rate of trade discount and the amount on which such discount is allowed.

The journal entry should be :

Cash / Debtor Account Dr. $9000

To Sales Account $9000

(Being goods sold in cash/credit and allowed a trade discount of 10% on $10000.)

Trade Discount do not appear in the financial statements. We do not create any ledger for this discount, nor we pass any journal entry for such amount of discount, so the question of appearing in the financial statements do not appear.

However, if in question, it is not mentioned whether it is a trade discount or cash discount, we will always assume it to be a cash discount.

Cash Discount : The purpose of this discount is discussed above. It is allowed for prompt payment of dues. It is recorded in the books of account by creating a separate ledger. This discount is received when payment is made or received. If trade discount is also received or allowed along with cash discount, then cash discount is calculated after deducting trade discount from invoice price i.e. cash discount is calculated on the net amount.

Suppose, Mr.Y sold goods worth $5000 in cash and allowed a cash discount of 5%. Then, we have to credit the Sales Account by $5000 and debit Cash Account by $4750 and Discount Allowed Account by $250.

The journal entry should be :

Cash Account Dr. $4750

Discount Allowed Account Dr. $250

To Sales Account $5000

(Being goods purchased in cash and discount received @ 5%.)

Now suppose, a problem appears where we are given both trade discount and cash discount.
Example : Mr. X sold goods worth $50000 and allowed a trade discount of 10% and cash discount of 5%.

Then entry should be :

Cash Account Dr. $42750

Discount Allowed Account Dr. $2250

To Sales Account $45000

(Being goods sold in cash and allowed a trade discount of 10% and cash discount of 5%.)

Cash Discounts appears in th Financial Statements. If cash discount is allowed, then it will appear as Discount Allowed under INDIRECT EXPENSES. If cash discount is received, then it will appear as Discount Received under INDIRECT INCOMES.

3. Sales to customers using credit cards are recorded as normal sales. If the customer is instantly paying the full amount for the goods purchased using credit cards, then it will be recorded as normal sales. However, if the customer using credit cards makes payment in instalments, then the customer will remain my debtor till the last instalment until all his payments gets cleared. The customer will appear as a debtor for the balance amount due, that is yet to be received from such customer.

Thank you!