Preparing Basic Management Reports: Financial Statements

Prepare basic management reports: financial statements

Contents

Introduction

Preparing statements for management

Sales returns and purchases returns

Discounts allowed

Discounts received

This learning guide is based on the following resource:
Textbook
Duncan A (2006) Introductory Accounting, National Core Accounting Publications, Bondi

Key to resources

Resource / Textbook
1 / Chapter 9 ‘Basic Accounting Reports’
2 / Chapter 9:

self-testing exercises 1(a), 2, 3 and 4
end of chapter exercises, questions. 2, 4, 6 and 8

Introduction

You would have looked at how we prepare financial statements for a service industry business for a period—and you would have prepared the trial balance, income statement and balance sheet.

Preparing statements for management

The purposes of preparing these statements for owners and management are:

income statement—to arrive at the profit or loss for the period
balance sheet—to identify the financial position at the end of the period.

An account is opened in the general ledger entitled ‘Profit and loss account’. This account acts as a clearing account for the revenue and expense accounts which are closed off by transfer to this profit and loss account.

After closing off the revenue and expense accounts to the profit and loss account, the remaining accounts with balances are the asset, liability and owner’s equity (capital and drawings) accounts. These accounts are then the basis of the balance sheet.

We will expand the preparation of financial statements to include a retail industry business. Also, the financial statements will be prepared in a classified format with accounts grouped under appropriate headings within the statements.

Accounting for inventory-related transactions here will be on the basis of the business using the perpetual inventory system.

The income statement for a retail industry (merchandising) business will effectively have two sections. The first section is the operating revenue—the revenue from sales—which is matched against the cost of goods sold to arrive at the gross profit for the period. The second section is the operating expenses section. The operating expenses are deducted from the gross profit to arrive at the net profit for the period. The trading elements, the operating revenue and cost of goods sold section, will have another account opened in the general ledger entitled ‘Trading account’ which will be the clearing account for the relevant revenue and expense accounts, in the same manner as the profit and loss account.

Also covered will be the preparation of the basic closing entries associated with the income statement and the trading and profit and loss accounts in the general ledger, including the profit or loss transfer to the owner’s capital account. If a separate drawings account is in use, the transfer to capital will also be demonstrated.

/ Now go to Resource 1
/ Now go to Resource 2

Sales returns and purchases returns

Some businesses will use separate general ledger accounts to record when a business either receives goods back from a customer (sales returns) or returns goods to a supplier (purchase returns). If they do use separate general ledger accounts, these accounts will need to be offset against the original sales general ledger account or purchases general ledger account at the end of the reporting period for the business (usually each year).

The journal entry to offset the balance of the sales returns account to the sales account would be:

Debit Sales
Credit Sales returns

Alternative treatment

You do not need to use separate general ledger accounts for returns. You can simply record them directly in the same general ledger accounts used when goods were sold or purchased (as a reduction to the account). So, for sales returns, they can be recorded in the sales account. For purchase returns, it will depend on what inventory method is being used, ie the perpetual or the periodic method. If you are using the periodic method, the original purchase would have been recorded as a debit entry in the Purchases account. So the purchase return will be recorded as a credit entry in the purchases account.

However, if you are using the perpetual method, the original purchase would have been recorded as a debit entry in the inventory account. Therefore, the return would be recorded as a credit entry in the inventory account.

To record these returns in the journals, they should be shown as a negative entry under the sales column in the sales journal or the inventory column in the purchases journal.

Example

SDJ
Date / Invoice no. / Particulars / Fol / Accounts receivable / Sales / GST clearing / General
20xx / $ / $ / $ / $
Mar 17 / 100024 / North East Wholesalers / 550.00 / 500.00 / 50.00
Mar 18 / C00895 / North East Wholesalers / (55.00) / (50.00) / (5.00)

Discounts allowed

When goods are sold on credit, the customer will pay their account at a later date. In some cases, we may offer a discount to encourage an earlier payment. It is important to record these discounts as part of the receipt transaction. As a result, you will see cash receipt transactions that also include the discount allowed. The cash receipts journal may use a separate column (and general ledger account) to record the discount allowed.

CRJ
Date / Receipt no / Particulars / Fol / Bank / Accounts receivable / Disc allowed / GST clearing / General
20xx / $ / $ / $ / $
Mar 17 / 87652 / South East Retailers / 495.00 / 550.00 / (50.00) / (5.00)

However, the accounting standards require that the value of sales be recorded after offsetting any discounts allowed to customers. Therefore, the discounts allowed will need to be deducted from the sales account. If the receipt transaction is recorded using a discount allowed account, this offsetting transaction will be done at a later date—usually at the end of the reporting period for the business (usually each year). This is the method used in the recommended textbook. However, as an alternative, this offsetting transaction may be done at the same time that the receipt is recorded. In this case the discount allowed would be shown in the cash receipts journal as a negative entry in the sales column.

CRJ
Date / Receipt no / Particulars / Fol / Bank / Accounts receivable / Sales / GST clearing / General
20xx / $ / $ / $ / $
Mar 17 / 87652 / South East Retailers / 495.00 / 550.00 / (50.00) / (5.00)

Either method is suitable. It is important to note that at the end of the reporting period, the value of the sales account to be recorded in the income statement would be the total of sales less any discounts allowed.

Discounts received

When goods are purchased on credit, the business will pay the supplier’s account at a later date. In some cases, we may be offered a discount to encourage an earlier payment. It is important to record these discounts as part of the cash payment transaction. As a result, you will see cash payment transactions that also include the discount received. The cash payments journal may use a separate column (and general ledger account) to record the discount received.

CPJ
Date / Cheque no / Particulars / Fol / Bank / Accounts payable / Discount received / GST clearing / General
20xx / $ / $ / $ / $
Mar 17 / 87652 / South East Retailers / 495.00 / 550.00 / (50.00) / (5.00)

However, the accounting standards require that the value of inventory (when using the perpetual inventory method) be recorded after offsetting any discounts received from suppliers. Therefore, the discounts received will need to be deducted from the inventory account. If the payment transaction is recorded using a discount received account, this offsetting transaction will be done at a later date—usually at the end of the reporting period for the business (usually each year). This is the method used in the recommended textbook. However, as an alternative, this offsetting transaction may be done at the same time that the payment is recorded. In this case, the discount received would be shown in the cash payments journal as a negative entry in the inventory column.

CPJ
Date / Cheque no / Particulars / Fol / Bank / Accounts payable / Inventory / GST clearing / General
20xx / $ / $ / $ / $
Mar 17 / 87652 / South East Retailers / 495.00 / 550.00 / (50.00) / (5.00)

Either method is suitable. It is important to note that at the end of the reporting period, the value of the inventory account to be recorded in the balance sheet would be reduced by the effect of any discounts received.

Prepare basic management reports: financial statements1