Introduction to Sales and Purchases
Welcome! In this chapter, we are looking at the "bread and butter" of every business: Sales and Purchases. Think of it like this—a business is a machine that buys things (Purchases) to either sell them directly or turn them into something else to sell (Sales). Recording these correctly is the foundation of all financial accounting. Don't worry if this seems like a lot to take in; we'll break it down step-by-step.
1. Cash vs. Credit Transactions
In the world of accounting, not all sales and purchases happen with cash immediately. We categorize them into two types:
Cash Transactions: The goods are exchanged, and the money is paid right away (for example, paying by debit card at a shop).
Credit Transactions: The goods are exchanged now, but the payment happens later, creating a contractual obligation or right to pay (for example, ordering inventory and receiving a supplier invoice payable in 30 days).
Key Terms to Remember:
• Receivables: Customers who owe the business money for credit sales.
• Payables: Suppliers whom the business owes money to for credit purchases.
Quick Review: Selling on credit creates a Receivable (Asset). Buying on credit creates a Payable (Liability).
2. Understanding Discounts
Discounts reduce the price of goods or services. In the ACCA syllabus, you must distinguish between trade discounts and settlement discounts, and record them in accordance with IFRS Accounting Standards.
A. Trade Discounts
A trade discount is a reduction given by a seller against the list catalogue price at the time of purchase, typically for bulk buying or customer loyalty.
The Golden Rule: Record transactions NET of trade discounts. Trade discounts are never recorded in a separate general ledger account.
B. Settlement Discounts Allowed (IFRS 15)
A settlement discount (cash discount) is offered to encourage credit customers to settle their invoices promptly (for example, "2% discount if paid within 10 days").
Under IFRS 15 Revenue from Contracts with Customers, settlement discounts offered to customers are treated as variable consideration:
• Customer expected to take the discount: Record the initial credit sale and receivable net of the prompt payment discount.
• If the customer subsequently pays within the discount period: Debit Bank and Credit Receivables for the discounted amount.
• If the customer fails to pay on time: The customer pays the full undiscounted invoice price. The extra cash received is credited to revenue (or settlement discounts forfeited).
• Customer not expected to take the discount: Record the initial credit sale and receivable at the full invoice price. If the customer unexpectedly pays early, reduce revenue accordingly.
C. Discounts Received
Discounts received are prompt payment discounts given to your business by suppliers for settling purchase invoices early.
Accounting Treatment: The initial purchase is recorded at the full invoice price (less any trade discount). When paying within the discount period, the discount received is recorded as other income or a credit entry to the Discounts Received general ledger account:
Debit: Payables (clears the full invoice liability)
Credit: Cash/Bank (actual cash paid)
Credit: Discounts Received (income)
3. Sales Tax
Most businesses act as tax collection agents for tax authorities. When selling goods, they collect Sales Tax (such as VAT); when buying goods, they pay sales tax.
• Output Tax: Sales tax charged on taxable sales (a liability owed to the tax authority).
• Input Tax: Sales tax paid on taxable purchases and expenses (an asset recoverable from the tax authority by registered businesses).
Important Principle: Sales revenue and purchase expenses are recorded NET of recoverable sales tax in the statement of profit or loss. Recoverable input tax and payable output tax are tracked in the Sales Tax Control Account.
The Calculation Formulas:
\( \text{Gross Price} = \text{Net Price} + \text{Sales Tax} \)
If sales tax is 20%:
\( \text{Gross Price} = \text{Net Price} \times 1.20 \)
\( \text{Net Price} = \frac{\text{Gross Price}}{1.20} \)
\( \text{Sales Tax} = \text{Gross Price} \times \frac{20}{120} = \text{Gross Price} - \text{Net Price} \)
4. Books of Prime Entry
Before transactions are posted to individual general ledger accounts, they are listed chronologically in Books of Prime Entry:
1. Sales Day Book: Lists all credit sales invoices issued to customers.
2. Purchase Day Book: Lists all credit purchase invoices received from suppliers.
3. Sales Returns Day Book: Lists credit notes issued to customers for returned goods (returns inwards).
4. Purchase Returns Day Book: Lists credit notes received from suppliers for returned goods (returns outwards).
5. Cash Book: Records all receipts and payments through bank accounts and cash.
5. Recording the Double Entry
Applying the fundamental rules of double entry (Debit increases Assets and Expenses; Credit increases Liabilities and Income):
Recording a Credit Sale:
When goods are sold on credit subject to sales tax:
Debit: Receivables (Asset increases with the gross invoice total)
Credit: Sales (Income increases with the net sales amount)
Credit: Sales Tax (Liability increases with the output tax)
Recording a Credit Purchase:
When inventory is purchased on credit with recoverable sales tax:
Debit: Purchases (Expense increases with the net purchase amount)
Debit: Sales Tax (Asset increases with recoverable input tax)
Credit: Payables (Liability increases with the gross invoice total)
Recording Sales Returns (Returns Inwards):
When a customer returns goods, the original sale is reversed:
Debit: Sales Returns (reduces revenue)
Debit: Sales Tax (reduces the output tax liability)
Credit: Receivables (reduces the customer's outstanding balance)
Recording Purchase Returns (Returns Outwards):
When your business returns goods to a supplier:
Debit: Payables (reduces the liability owed to the supplier)
Credit: Purchase Returns (reduces cost of purchases)
Credit: Sales Tax (reduces recoverable input tax)
6. Summary and Key Takeaways
• Trade Discounts: Deducted upfront; transactions and day books record net amounts only.
• Settlement Discounts Allowed: Accounted for under IFRS 15 based on expected entitlement at transaction date.
• Discounts Received: Recorded as a credit entry to Discounts Received when paying suppliers early.
• Sales Tax: Revenue and purchases are recorded net of recoverable tax; output tax is a liability and input tax is an asset.
• Returns: Sales returns reverse the original credit sale entry; purchase returns reverse the original credit purchase entry.