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Provision for Discounts

Sellers want to be paid quickly for their sales and so they offer discount for payment within a given time. Buyers in response make prompt payment for their debts and enjoy the discount which is a loss to the company allowing the discount. Discount is not a cash payment and this causes the company to receive less cash for their sales than they would after the maturity of the debts. So a provision for discount on debtors is necessary to meet the discounts allowed to the debtors during the next year when they make their payments on time.

Discount allowed for quick payment should be charged in the period in which the goods are sold on credit. It is because of these sales that discounts are given. Sometimes goods are sold on credit to customers in an accounting period which is usually a year but payments for the sales are received in the following year. As the customers are entitled to the discounts allowed, a provision for discount is therefore created at the end of the year for next year’s discount.

The provision for discount on debtors is calculated as a percentage of the good debtors, that is debtors balance after deducting bad debts and provision for bad debts as discounts are not allowed on bad debts. As an expense item, the provision is shown on the debit side of the Profit and Loss account. The corresponding credit entry is recorded in the provision for discount account. The provision is a current liability but on the balance sheet, it appears on the asset side as a deduction from net trade debtors.

An increase in the provision for discount on debtors is treated as an expense, and a decrease in the provision is an income which is also posted to the profit and loss account but on the credit side. The following are account entries for the provision for discount:

For the first year that the provision is created:
Debit profit and loss account
Credit provision for discounts account

To increase the provision:
Debit profit and loss account
Credit provision for discounts account

To decrease the provision:
Debit provision for discounts account
Credit profit and loss account

Year ended December 31
20X1 20X2 20X3
Debtors ($) 6,000 6,550 5,500
Provision for bad debts ($) 300 250 200
Provision for discounts (%) 2 2 2
Provision for discounts ($)
114 126 106


For the first year that the provision is created:

Provision for Discounts on Debtors Account

Date Particulars Folio Amount
Date Particulars Folio Amount
$
20X1
Dec 31 Profit and loss 114


To increase the provision:

Provision for Discounts on Debtors Account

Date Particulars Folio Amount
Date Particulars Folio Amount
$
20X2 20X2
Jan 01 Balance b/d 114
Dec 31 Balance c/d 126 Dec 31 Profit and loss 12
126 126


To decrease the provision:

Provision for Discounts on Debtors Account

Date Particulars Folio Amount
Date Particulars Folio Amount
$
20X3 20X3
Dec 31 Profit and loss 20


" Balance c/d 106 Dec 31
Balance b/d
126
126 126
Jan 01 Balance b/d 106


Profit and Loss Account for the year ended 31 December, 20X-

$ $
Gross profit (20X1) XXX
Less: Expenses
Provision for discounts on debtors 114
Gross profit (20X2) XXX
Less: Expenses
Provision for discounts on debtors (Increase) 12
Gross profit (20X3) XXX
Add: Reduction in provision for discounts on debtors 20

XXX


Balance Sheet as on 31 December

$ $ $
20X1 Debtors 6,000
Less: Provision for bad debts 300
Less: Provision for discounts on debtors 114 414 5,586
20X2 Debtors 6,550
Less: Provision for bad debts 250
Less: Provision for discounts on debtors 126 376 6,174
20X3 Debtors 5,500
Less: Provision for bad debts 200
Less: Provision for discounts on debtors 106 306 5,194

Last Updated (Friday, 03 September 2010 19:38)