PROVISION FOR DISCOUNTS

FIRST TERM E-LEARNING NOTE

SUBJECT: FINANCIAL ACCOUNTING 

CLASS: SS 2

WEEK THREE

FINAL ACCOUNTS – PROVISION FOR DISCOUNTS

If a trader usually allows and receives cash discounts the debtors and creditors balances in the

Balance Sheet at the end of the year may be overstated unless it is recognized that discounts

are likely to be deducted from them.  This is done by creating provision for discounts on

debtors and provision for discounts on creditors.

PROVISION FOR DISCOUNTS ON DEBTORS

This is a charge made against profit in order to provide for an expected loss in the shape of discounts that will have to be allowed to the firms debtors to facilitate prompt payment of their accounts.

The provision for discount on debtors should be calculated on the net amount /figure of debtors after deducting any provision for doubtful debts.  This treatment should be obvious in that discounts are not allowed on doubtful debts.

The Accounting entries involved when the provision for discount allowed is first created:

Debit              Profit and Loss Account

Credit              Profit for discounts allowed with the full amount of the provision.

In the years that follow the entries in the accounts will be for increases or decreases in the amounts required for the provision.

To record these subsequent entries the procedure is similar to the doubtful debts provision.

EVALUATION QUESTIONS

1. Explain the following terms

(a)  Discounts Allowed     (b) Cash Discounts

2. State two differences between Discount Allowed and Discount Received

PROVISION FOR DISCOUNTS ON CREDITORS

It is also the practice of some businesses to recognize the fact that the amount of creditors at the balance sheet date does not represent the amount which will be paid.  This is because where advantage is taken of cash discount arrangements, a smaller sum will be payable to discharge the debts.

The provision for discounts on creditors thus created is an addition to the profits and is to provide for those discounts expected to be received on payment of the firms creditors.

The accounting entries involved when the provision for discount received is first created:

Debit               Profit for discount received

Credit              Profit and Loss Account

In the years that follow the entries in the accounts will be for increases or decreases in the amount required for the provision.  This will be treated along similar lines as outlined above.

It should be stated that creating a provision for discount received contravenes the accounting convention of conservatism as it clearly anticipates income that has not arisen.  However, it can be argued that if a firm creates a provision for discounts on debtors, it should also take into account discounts on creditors.

EVALUATION QUESTION

1. Differentiate between provision for bad debts and provision for discounts on debtors.
2. List four items of current assets in the balance sheet of a business.

GENERAL EVALUATION

• What is the effect of understatement of closing stock on: (a) cost of sales (b) grossprofit (c) net profit
• State five causes of a decline in the net profit of a business
• Differentiate between ‘‘Discount Allowed” and ‘’Discount Received”
• State five characteristics of the imprest system of keeping petty cash records
• List four characteristics of each of the following (a) fixed assets (b) current assets(c) intangible assets

READING ASSIGNMENT

Simplified and Amplified Financial Accounting Page 143-150

WEEKEND ASSIGNMENT

1. The total debtors account of a trading concern is N13,000. Out of this 2% is irrecoverable. 5% of the balance is not likely to be collected.  What is the provision for doubtful debts

(a) N910       (b) N650     (c) N637      (d) N260

2. An allowance given to a customer by a supplier for prompt payment is ______

(a) trade discount     (b) discount received    (c) cash discount   (d) cash rebate

3. Which of the following is the effect of an increase in the provision for discount allowed_______

(a) increase in net profit          (b) decrease in gross profit    (c) decrease in net profit

(d) increase in gross profit

4. The opening balance of debtors is N100,000 and that of provision is to be at 2 ½ % of debtors, how much would be charged in the Profit and Loss Account

(a)  N3,500      (b)  N2,500     (c)  N1,500        (d) N1,000

5. Omolomo Limited gave Omolope a discount of 10% on purchases. If the discount enjoyed in the year amounted to N250, what is the total purchases ____

(a) N2,750        (b) N2,500        (c) N2,250        (d) N2,000

THEORY

The existing provision for doubtful debts in the books of Segun Enterprises was N4,480.  On 31^STDecember, 2005, the trade debtors stood at N78,400.

Using journal entries and ledger entries, you are required to:

(a)        Reduce the provision for doubtful debt to N3,920

(b)        Create a provision for discounts on debtors at 2 ½ %.

(c)        Show how the items would appear in the Profit and Loss Account and Balance Sheet.

1. Understatement of closing stock can have a number of different effects on a business, including changes to cost of sales, gross profit, and net profit.
2. Some possible causes of a decline in net profit may include shrinking margins due to increased competition, increases in operating costs or expenses, shifts in consumer demand or preferences, or changes in the economic environment. Other factors that may influence net profit include fluctuations in exchange rates, shifts in market conditions or demand, changes in tax policies or regulations, or other external forces. Some key characteristics of fixed assets typically include items such as land and buildings, long-term investments or property that are used to generate income over an extended period of time.
3. Meanwhile, some common characteristics of current assets may include items such as cash, accounts receivable, inventory, and other short-term investments. intangible assets can include things like intellectual property or goodwill, and typically have a value that is difficult to quantify. Ultimately, the key to improving net profit in a business is understanding the various factors that can influence it, and taking steps to mitigate risks and manage these factors effectively.
4. Differentiate between ‘‘Discount Allowed” and ‘’Discount Received”

Discount allowed refers to a reduction in the price of an item that is offered by a seller, typically as part of a promotional offer or discount program. This can be understood as the amount that a buyer is able to save on a purchase due to this discounted price. In contrast, the discount received refers to a reduction in the price that is offered by a buyer, typically as part of a negotiation or bargaining process. This can be understood as the amount that a seller is able to save on a sale due to this reduced price. Both discounts allow buyers and sellers to negotiate prices and save money, but they differ in terms of who initiates the discount and who receives it. Furthermore, both discounts are typically expressed as a percentage of the original price of an item. Ultimately, understanding the difference between discount allowed and discount received is key for buyers and sellers when negotiating prices or seeking savings on purchases.

State five characteristics of the imprest system of keeping petty cash records

1. The imprest system of keeping petty cash records is a method that involves regular cash withdrawals and deposits to keep track of small amounts of money. Some key characteristics of this system may include regular auditing and reconciliation, strict accounting controls, the use of receipts or invoices to document transactions, strict limits on the amount of funds that can be kept in petty cash, and other factors that help to ensure the accuracy and reliability of records. Other potential benefits of this system may include improved efficiency and speed when it comes to handling small amounts of cash, as well as reduced risk of theft or fraud. Overall, the imprest system is a commonly used method for managing petty cash transactions and keeping track of small amounts of money, and it can be an effective tool for businesses or organizations seeking to maintain accurate records and ensure the security of their funds.
3. State three key features of a cash budget
5. 1. A cash budget is typically created on a monthly basis, and it can help businesses plan their cash flow more effectively by considering factors such as ongoing expenses, seasonal fluctuations, and unforeseen events or expenses.
7. 2. A cash budget typically includes a forecast of expected income based on sales or revenue projections, as well as an estimate of the amount of cash that will be required to cover ongoing costs such as payroll, inventory, and other operating expenses.
9. 3. Other key features of a cash budget may include the use of financial tools such as liquidity ratios or cash flow projections, and it may also involve regular monitoring and adjustment in response to changes in market conditions or other factors. Overall, a cash budget can be an important tool for businesses looking to effectively manage their cash flow and plan for the future.