CHAP 5: Returns, Discounts and Sales tax

RETURNS

SALES

When sales are made on cash

Dr Cash
Cr Sales

When sales are made on credit When these receivables are cleared'
Dr Receivables Dr Cash
Cr Sales Cr Receivables

Sales Return (Return inward)

When sales made on credit, are returned

Dr Sales Return
Cr Receivables

When sales made on cash, is returned

Dr Sales Return
Cr Cash

PURCHASE

When purchase are made on cash

Dr Purchase
Cr Cash

When sales are made on credit When these receivables are cleared'
Dr Purchase Dr Payables
Cr Payables Cr Cash

Purchase Return (Return outward)

When purchase made on cash, is returned

Dr Cash
 Cr Purchase Return

When purchase made on credit, are returned

Dr Payables
Cr Purchase return

DISCOUNT

Trade Discount

Discount given on list price (reduction in price)

It is always subtracted from invoice (not restricted by any condition)

Example:
List Price = Quantity * Rate
1000 50 * 20
If a 5% trade discount is given

Solution
5% of 1000 = 50

Therefore subtract from invoice (list price)

1000
-50
950

Recording for this sale,

Dr Cash/Receivables 950
Cr Sales 950

Bulk Discount

Discount if bulk of goods are purchased/sold

It is NOT always subtracted from invoice (restricted by condition of number of goods)

Example:
List Price = Quantity * Rate
1000 20 * 50
If a 5% trade discount is given
 If a 4% bulk discount is given for quantity purchased over 15

Solution
First provide for TRADE DISCOUNT
5% of 1000 = 50

Therefore subtract from invoice (list price)

1000
-50
950

Next calculate BULK DISCOUNT

4% of 950 = 38

950
-38
912

Recording for this sale,

Dr Cash/Receivables 912
Cr Sales 912

Settlement/ Cash/ Prompt payment discount

NOTE This is only for CREDIT TRANSACTION

SELLER PERSPECTIVE (GIVING DISCOUNT TO CUSTOMERS)

Example Scenario to understand what this discount is about

The credit period given might be 30 days
and we would tell customer that if you pay within 10 days, you can get 10% discount

Now the calculation becomes a little complex because we don't know whether the customer is going to take dis
They may pay in 10 days, may pay in 30 days

Example Question

The sales made is for $1000 and 20 days credit period

We offer settlement discount of 5% if they pay in 10 days

Solution
Now problem is we don't know if they'll pay or not in 10 days

Check for past history

POSSIBLITY 1 Acc to history, customer does take discounts and pay early
So we can expect this time also the same to happen with customer

Then after discount of 5%, the price to be recorded is 950

Dr Receivables 950
Cr Sales 950

Outcome 1 Customer takes the discount just like we expected and pays in 10 days
Dr Cash 950
Cr Receivables 950

Outcome 2 Customer DOESN'T take the discount and pays in 20 days

Dr Cash 1000
Cr Receivables 950 We can only reduce 950 because we have only reco
Cr Sales 50 We add 50 sales because we have only recorded 95

POSSIBLITY 2 Acc to history, customer DOESN'T take discounts. They'll pay late
So we can expect this time also the same to happen with customer

Then the price to be recorded is 1000

Dr Receivables 1000
Cr Sales 1000

Outcome 1 Customer DOESN'T take the discount just like we expected and pays in 20 days
Dr Cash 1000
Cr Receivables 1000

Outcome 2 Customer takes the discount and pays in 10 days

Dr Cash 950 Because after discount, only 950 cash is received fro
Dr Sales 50 Because we had previously recorded full 1000, so to
Cr Receivables 1000 Reduce full 1000 because that's what we recorded a
PURCHASER PERSPECTIVE (TAKING DISCOUNT FROM SUPPLIERS)

Here there is no complication of not knowing of outcome

Because it is who is taking the discount, so we know whether we'll take or not

Example Supplier gives invoice of $1000 for 20 days, and 5% discount if paid within 10 days

Initial Dr Purchase 1000

Cr Payables 1000 Record It at invoice value itself

Outcome 1 We Don't take the discount and pay in 20 days

Dr Payables 1000
Cr Cash 1000 Normal entry

Outcome 2 We take the discount of 5% and pay in 10 days (950)

Dr Payables 1000
Cr Cash 950
Cr Discount received 50 Its like an income
SALES TAX
Sales tax is also known as Value Added Tax (VAT)
Its an INDIRECT TAX

Not all companies will have Sales tax

Based on country's tax rules, (mostly based on company's revenue threshold)
if a company has certain amount of revenue, then they'll have to register for sales tax

Once registered with sales tax authorities, they're invoice will also have tax value

Example If the invoice is $100, and 20% is sales tax, then final invoice value is $100 + $20 = $120
Some terminologies related

Net Value $100 Tax Exclusive Value

$20 Tax
Gross Value $120 Tax Inclusive Value

Out of this collected $120,

$100 Keep for themselves
$20 Pay tax to govt, called as OUTPUT TAX

Purchases

When a business purchase items from their suppliers, they have to pay tax to Supplier
because their invoice will be included with tax

It is to note that this tax which BUSINESS PAY TO SUPPLIERS IS RECOVERABLE FROM TAX AUTHORITIES
Reason : We pay tax to govt. on sales we make, so when we pay tax to suppliers, it’s a double effect
This tax that can be recovered from Tax authorities is called INPUT TAX
NOTE: Not all Taxes for Purchases are recoverable

Tax Calculations

Always follow the formula

Net + Tax = Gross
100 + number = Gross

Given Value / Its position in formula * Target Value

Example 1 Net value is 2000 and, tax is 20%, find gross

Formula 100 + 20 = 120
So gross = 2000/100*120 2400

Example 2 Gross value is 6000, tax is 10%, find tax

 Formula 100 + 10 = 110
So tax = 6000/110 * 10 545.4545

ACCOUNTING FOR SALES TAX

The rule for accounting entries related to tax are

Receivables, Payables, Cash Record at GROSS VALUE

Purchase, Purchase Return Record at NET VALUE

Sales, Sales Return Record at NET VALUE

Example Net 100

Tax 20
Gross 120

For Credit sale Dr Receivables 120

Cr Sales 100
Cr Tax 20

For Credit Purchase Dr Purchase 100

Dr Tax 20
Cr Payables 120

Easy tip to understand:

The entry for tax will be same as the nature of the item

Sales is Cr Tax is Cr
Sales Return is Dr Tax is Dr

Purchase is Dr Tax is Dr
Purchase Return in Cr Tax is Cr

Example A credit sale of $2000 inclusive of sales tax at 20%

Net + Tax = Gross

100 + 20 = 120
Applying the formula previously learnt

Net 1667
Tax 333
 Gross 2000

Dr Rec 2000
Cr Sales 1667
Cr Tax 333

T ACCOUNT

Sales Tax T Accounts

Can having opening balance on Debit side if mentioned

Tax is receivable Purchases

Can having opening balance on Credit side if mentioned

Tax is payable Sales

Sometimes you might see Cash payment made in questions

This cash payment reduces sales tax, hence will be shown on Debit side

Example
1 Tax payable $2000 at start of year
2 Sales of $50000 including tax at 20%
3 Purchases of $30000 excluding tax at 20%
ales tax
he customer is going to take discount
950 because we have only recorded 950
ause we have only recorded 950, but cash got is 1000

ays in 20 days

nt, only 950 cash is received from customer

viously recorded full 1000, so to reduce it by 50, we Dr Sales
cause that's what we recorded at first
aid within 10 days
register for sales tax

is $100 + $20 = $120

ROM TAX AUTHORITIES

it’s a double effect
INVENTORY - IAS 2
These are current assets of the company that is held for RESALE OR CONSUMPTION PURPOSE
(normal goods) (diesel for generators)

Cost of Goods Sold (COGS) OR Cost of Sales (COS)

Opening Inventory Statement of Profit and Loss

+ Purchases Revenue
- Closing Inventory Less: COS
Cost of Sales Gross Profit

Understanding Opening and Closing Inventory

Opening Inventory These will be sold

+ Purchases
- Closing Inventory These will NOT be sold
Cost of Sales

Opening Inventory
These will be sold, hence its PART OF THE COST OF GOODS SOLD
These will be sold, hence its NOT AN ASSET ANYMORE

Journal Entry :
Dr COS SOPL
Cr Inventory SOFP

Closing Inventory
These will NOT be sold, hence its NOT PART OF THE COST OF GOODS SOLD
 These will NOT be sold, hence its STILL AN ASSET

Journal Entry :
Dr Inventory SOFP
Cr COS SOPL

INVENTORY VALUATION

Inventory consists of

1 Goods for resale

2 Goods for consumption purpose
3 Raw materials for production
4 Partly finished goods (Work in progress)
5 Finished goods (completed manufacturing)

Inventory is Valued at LOWER of

COST and Net Realisable Value (NRV)

COST = Costs necessary to bring it into present location (delivery and manufacturing cost)
Purchase price (less: trade discount)
Material costs
Import duties
freight charges
production overheads (aka cost of factory)
Direct cost (material, labour, expenses)

DO NOT INCLUDE IN COST

Non production costs (selling cost, admin cost)
Storage cost (like warehouse rent)
Abnormal cost (like obsolete goods, damaged goods, stolen goods)

NRV = Estimated selling price

Less: Cost to complete (if item is in WIP, then cost to complete the production)
Less: Cost to sell (eg: comission to be paid for the sale to an agent)

Disclosure Note

Detailed breakdown of what are costs included, and how was calculation done
What is the quantity of goods, what is the nature of it etc.
METHODS OF INVENTORY VALUATION

Inventory is valued at LOWER of COST and NRV

Now the problem is Cost for a product may change over the period
The same inventory may have cost of $10 at beginning of year, $15 6 months later, $18 at year end
In such a scenario, which cost do we consider for valuation?

Technique 1 : First in First Out (FIFO)

Products purchased at earlier periods are sold first
So the cost of last products bought, will be the cost taken for inventory valuation at closing
 (because last products will be the one remaining in inventory)

Technique 2 : Last in First Out (LIFO)

Products purchased at later periods are sold first
So the cost of early products bought, will be the cost taken for inventory valuation at closing
(because early product will be the one remaining in inventory)

Technique 3 : Average Cost

Two types under this:
1 Periodic Weighted Average Cost Average is found just once after period end
2 Continuous Weighted Average Cost Average is found after every transaction

Answer TIP : Always draw 3 columns,

Receipts (Purchases)
Issues (Sales) if qstn asks to find COS, then find the total in Sales column
Balance (Store balance) if qstn asks to find Closing inv, then find the total in Balan
generators)
18 at year end

uation at closing
aluation at closing

Average found once after all purchases regardless of date order. That is used as the rate
Average found at every date, and calculation goes in date order

nd the total in Sales column

then find the total in Balance column
 Find the Net, Gross and Tax amount . And also write the double entries for it.

All are cash sales and cash purchases

1 Sales exclusive of tax is 25000 and the tax applied is 17.5%.

2 Purchase inclusive of tax is 30000 and the tax applied is 15.5%.

3 Sales return inclusive of tax is 12000 and tax applied is 12%

4 Purchase return exclusive of tax is 12500 and tax applied is 7.5%