Question

Assume you are a business consultant. The owner of a company sends you an e-mail expressing concern that the company is not taking advantage of its discounts offered by vendors. The company currently uses the gross method of recording purchases. The owner is considering a review of all invoices and payments from the previous period. Due to the volume of purchases, however, the owner recognizes that this is time-consuming and costly. The owner seeks your advice about monitoring purchase discounts in the future. Provide a response in memorandum form. (Hint: It will help to review the recording of purchase discounts in Appendix 4D.)

Short answer

Answer

When purchases are recorded at net amounts, a discount lost expense is brought to management’s attention as an operating expense on the income statement. Management can then seek to identify the reason for discounts lost, such as oversight, thoughtlessness, or ominous terms.

Step-by-step solution

Step-by-Step SolutionStep 1: Introduction to topic

Memorandum: A memorandum is a composed message normally utilized in a professional setting. Generally abbreviated "memo," these messages are typically short and are intended to be effectively and immediately comprehended.

Providing response in Memorandum Form

Memorandum To: “Owner” From: “Consultant” Date: __________ Subject: Advice on monitoring purchase discounts [Instructor’s Note: The response ought to recognize the owner’s concern and recommend the net method of recording purchases. It should explain how this strategy brings about the recording of “Discounts Lost,” which will flow through to the income statement, thus providing the information desired. The memo might look something like the following.] The net method gives management a benefit in controlling and monitoring purchase discounts. When invoices are recorded at gross amounts, the number of discounts taken is deducted from the balance of the Merchandise Inventory account. It implies that the amount of any discounts lost is not reported in any account or on the income statement. Therefore, discounts lost are unlikely to come to the attention of management. However, when purchases are recorded at net amounts, a discount lost expense is brought to management’s attention as an operating expense on the income statement. Management can then seek to identify the reason for discounts lost, such as oversight, thoughtlessness, or ominous terms. This practice gives management better control over persons responsible for paying bills on time to take advantage of favourable discounts. It also means it’s less likely that favourable discounts are lost.