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In today’s class, we will be talking about final accounts – provision for discounts. Enjoy the class!
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 to provide for an expected loss in the shape of discounts that will have to be allowed to the firm’s 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.
- Explain the following terms (a) Discounts Allowed (b) Cash Discounts
- 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 the 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 firm’s 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.
- Differentiate between provision for bad debts and provision for discounts on debtors.
- List four items of current assets in the balance sheet of a business.
- What is the effect of understatement of closing stock on (a) cost of sales (b) gross profit (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
In our next class, we will be talking about Final Accounts – Accruals and Prepayments. We hope you enjoyed the class.
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