To identify offsets, parenthesis is used with the final report read by owners and the management team.
Bookkeeping entails both data entry into books (journals and ledgers) and reporting information via the two primary financial statements.
In Lesson 13 it was explained how a debit based or credit driven account type for the balance sheet reports opposite values by using parenthesis. Both contra and atypical values are reported with parenthesis. The same presentation format is used when reporting contra and atypical values on the profit and loss statement (income statement).
To help you understand the use of parenthesis on the income statement this lesson is going to cover each type of account and explain the common contra and atypical balances.
Revenue accounts including sales are traditionally credit driven. However, there are some contra and atypical accounts that carry debit balances. In lesson 12, it was illustrated with the use of contra accounts associated with returns and allowances. Both of these are based on the customer interaction after the sale.
However, before a sale is consummated there are forms of enticement to get that customer to make a purchase. Enticements include marketing campaigns and discounts. Many bookkeepers use discounts as a primary account. When you review the revenue section it will look something like this:
Sales at Full Price $Z,ZZZ,ZZZ
Discounts (Atypical Account) (ZZZ,ZZZ)
Sales at Contracted Price Z,ZZZ,ZZZ
Adjustments: (Contra Accounts)
Sub-Total Adjustments (ZZZ,ZZZ)
Net Sales ZZZ,ZZZ
Other Revenues ZZZ
Total Revenue $ZZZ,ZZZ
Cost of Sales
The most common credit based account in cost of sales is discounts with purchases. Remember cost of sales is customarily debits as illustrated in the purchase journal.
Date Ledger Description DR CR
09/02/15 COS-Materials Lumber $1,606.27
A/P – Lowes Lumber ______ $1,606.27
Many suppliers offer discounts, a reduced price, if you pay earlier than the customary cycle or billing due date. The most common discount amount is 1.5%. Thus, if Lowe’s is paid by the discount date then the business receives a $24.09 discount. This is often recorded in the case disbursements journals as follows:
Date Ledger Description DR CR
9/08/15 A/P – Lowes Payment $1,606.27
Discounts Lowes – 24.09
Cash Check #101 1,582.18
Just to make sure you understand the entry above; first as required for dual entry total debits and credits must be equal. The debit value is $1,606.27 and completely nullifies the credit balance in accounts payable. The two credit entries equal $1,606.27, therefore the journal entry is in balance.
Lowe’s is allowing a lower price contingent on early payment. Therefore, the business pays $1,582.18 and there is a credit posted to discounts for $24.09.
Discounts related to purchases is a cost of sales type of account. Cost of sales is normally presented with debit values.
This begs the question ‘Are discounts contra or atypical accounts?’ Remember both are reported using parenthesis around the value because credit values are not the customary balance found in cost of sales accounts. Most accountants prefer the information as a contra account. The author’s opinion is that discounts should be a primary account (atypical) in cost of sales. This is because discounts are not a function of purchases but a function of available capital to pay early.
When discounts are used as a contra account the presentation format looks like this:
COST OF SALES
Net Materials 1,582.18
Total Cost of Sales $7,582.18
Notice that discounts offset (contra) purchases of materials. Whereas a primary account (atypical) and a function of available working capital the presentation format looks like this:
COST OF SALES
Gross Cost of Sales $7,606.27
Total Cost of Sales $7,582.18
Other credit based accounts found in cost of sales include:
- Returns – usually presented as a contra account
- Ending Inventory – usually used with the full method of accounting in retail cost of goods sold.
This part of the income statement rarely has contra or atypical accounts, but they do exist.
- Contra Accounts – some companies record interest earned on cash held by third parties as an offset to interest paid. When interest earned is a customary part of the business operations such as apartment complex operations the interest is reported as other revenue. For those with small amounts of interest earned, a contra account is set up in the chart of accounts as an offset to interest paid.
- Atypical Accounts – most of the time atypical accounts include refunds received from a supplier for a particular expense and there are no current debits for that particular expense during the accounting period. Think of a refund for your phone bill due to over-payment and you don’t pay for another month. Another example is a fuel refund, Form 4136, for tax refund of fuel costs.
Both contra and atypical accounts exist in all three types of accounts used with the income statement. Parenthesis identify these accounts when presented on the income statement. ACT ON KNOWLEDGE.
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