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

1. What is the effect of understatement of closing stock on: (a) cost of sales (b) grossprofit (c) net profit
2. State five causes of a decline in the net profit of a business
3. Differentiate between ‘‘Discount Allowed” and ‘’Discount Received”
4. State five characteristics of the imprest system of keeping petty cash records
5. 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.