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Bookkeeping – Debits and Credits in Parenthesis with the Profit and Loss Statement (Lesson 14)

Bookkeeping - Introduction and Basic Understanding / By David J Hoare MSA / 01/30/2016 01/11/2021

This site is dedicated to the investment strategy known as Value Investing. There are over 580 articles on this site about business tenets, principles and standards. During 2020, this site’s Value Investment Fund earned a 35.46% return. All of it was documented in the Value Investing Section. If you want to learn about value investing, click on the Value Investing tab in the header above.

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

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:

REVENUE
Sales at Full Price                                           $Z,ZZZ,ZZZ

Discounts (Atypical Account)                           (ZZZ,ZZZ)
Sales at Contracted Price                                 Z,ZZZ,ZZZ

Adjustments: (Contra Accounts)
        Returns                                  ($ZZ,ZZZ)
        Allowances                            (ZZZ,ZZZ)
        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
                                                                                 $1,606.27       $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
                                                                             $1,606.27         $1,606.27

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
          Materials                          $1,606.27
          Discounts                              (24.09)
          Net Materials                     1,582.18
          Labor                                 2,000.00
          Subcontractors                   3,000.00
          Other                                  1,000.00
          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
       Materials                             $1,606.27
       Labor                                    2,000.00
       Subcontractors                      3,000.00
       Other                                     1,000.00
       Gross Cost of Sales                              $7,606.27
       Discounts                                                  (24.09)
       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.

Value investing utilizes a buy low, sell high tenet of systematic processing with buying and selling stock investments. Along with patience, value investors reap substantially greater returns than most of the market measurment indices (DOW, Russell 2000, S&P, etc.). During 2020, this investment fund earned a 35.5% return while the DOW generated a 6.0% return. To date, the Investment Fund is 2.8X the return of the DOW and 2.5X the S&P 500 and the Composite 1500 Index. When you subscribe, you receive access to all existing articles, books, lessons, webinars and reports explaining how value investing works. For more information, click here: Membership Program.

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Expenses

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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There are four key principles used with value investing. Each is required. They are:

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    Value Investing is the Absolute Best Wealth Accumulation Method.

    Value investing is a systematic process of buying stock at low prices and selling once the stock price recovers. Its foundation is tied to four principles:
      1) Risk Reduction
      2) Intrinsic Value
      3) Financial Analysis
      4) Patience
    Learn about value investing and gain access to lucrative information that will improve your wealth. Expect annual returns in excess of 20%. The investment club’s results during 2020 were 35.4% and year-to-date for the second year it is tracking well over 34%. Lifetime to date, the Fund is 2.8X the return for the DOW and 2.5X the S&P 500.

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    Value Investing is the Absolute Best Wealth Accumulation Method.

    Value investing is a systematic process of buying stock at low prices and selling once the stock price recovers. Its foundation is tied to four principles:
      1) Risk Reduction
      2) Intrinsic Value
      3) Financial Analysis
      4) Patience
    Learn about value investing and gain access to lucrative information that will improve your wealth. Expect annual returns in excess of 20%. The investment club’s results during 2020 were 35.46%. The investment fund outperformed the DOW by a factor of 2.8X, 2.5X the S&P 500 and 2.5X the S&P Composite 1500.

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