Opinion on accounting treatment of trade discounts

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1 Opinion on accounting treatment of trade discounts ASSOCIATE PROFESSOR BUNGET OVIDIU-CONSTANTIN PhD West University of Timisoara Timisoara, 16 Pestalozzi Street ASSOCIATE PROFESSOR POPA IRIMIE-EMIL PhD Babes-Bolyai University of Cluj-Napoca Cluj-Napoca, Teodor Mihali Street LECTURER DUMITRESCU ALIN-CONSTANTIN PhD STUDENT West University of Timisoara Timisoara, 16 Pestalozzi Street ŞPAN GEORGETA-ANCUłA PhD STUDENT Babes-Bolyai University of Cluj-Napoca Cluj-Napoca, Teodor Mihali Street Abstract: Compliance with the accounting principles represents one of the prerequisites for obtaining a true and fair image by means of the financial statements. Thus, the true and fair image may be affected when accounting principles are not complied with. There was often a wrong approach in respect to trade discounts received after year-end i.e. impact on financial results and not on operating income, although the Romanian lawgiver has clearly stated this. But there were no special accounts in the chart of accounts, which is yet indicative and not limitary. Starting 1 January 2010 there have been some changes in the chart of accounts, just in order to offer practicing accountants some tools that should lead to improved techniques capable to provide a true and fair image. However, even after these changes, there are still outstanding issues is it correct to affect the results of the current year with the value of trade discounts received for inventories that have not been put into use as of the balance sheet date? The Romanian lawgiver relied on the short operating cycle of inventories, but the impact on the matching principle is obvious. Key-Words: accounting, trade discounts, matching principle, netting principle, inventories, operating income. ISSN: ISBN:

2 1. Introduction Compliance with the accounting principles represents one of the prerequisites for obtaining a true and fair image by means of the financial statements. Thus, the true and fair image may be affected when accounting principles are not complied with. Order of the Ministry of Public Finance ( OMFP ) no. 3055/2009 for approval of accounting regulations in compliance with European Directives presents the netting principle as follows: Any offset between assets and liabilities or between income and expenses items is forbidden. All assets and liabilities should be recorded separately in the accounts, based on supporting documents. Any offset between company s receivables and payables towards the same entity, performed in compliance with the legal provisions, should be registered only subsequent to registration of income and related expenses. The accounting regulations also establish how the exchange of assets should be reflected registration of sales and accounting discharge on one hand, and acquisition of the new asset on the other hand, together with registration of all income and expenses related to the transaction. As noted, the impact of accruals accounting is also met due to the application of this principle. Thus, the lawgiver claims that there should be no offset between receivables and payables as of the balance sheet date, even if they relate to the same third party, provided that up to that date no legal procedures for settling mutual liabilities were initiated and finalised. 2. Problem Formulation In order to apply the netting principle, the lawgiver has also provided the necessary tools for picturing both receivables and payables items. An example - advances received from clients are disclosed separately in liabilities, while non-collected amounts from clients are disclosed in assets under receivables. Another example - advances paid to suppliers are disclosed in assets under the category specific for the contract s scope of work (real estate, inventories or receivables, together with receivables from clients for services providers, which actually represents a violation of the principle of separate disclosure of assets and liabilities), while payables toward that supplier, which exist according to the previous invoices, are recognized and disclosed in liabilities. Another offset that can have an impact on the true and fair image refers to payables and receivables (that take the form of available funds) towards banks. If we think about the issue of offsetting balances of receivables and payables, this actually represents a foregoer of the main aspect dictated by this principle, namely netting of revenues and expenses. By reduction to absurdity, if we assume that the method for recognizing revenues and expenses is the net one (for the sale of goods only trade mark-up would be recognized in revenues), we would reach to the fact that only net results would be disclosed in the income statement, which would cancel the usefulness of this item of the financial statements. As such, the netting principle requires recognition of revenues at the absolute level of benefits driven by assets increase or liabilities decrease, as likewise, recognition of expenses should be made at the absolute level of consumption of assets or parts of them (see depreciation) or at the absolute level of liabilities increase. Trade discounts are an apparent exception to those mentioned above. Thus, Order of the Ministry of Public Finance no. 3055/2009 for approval of accounting regulations in compliance with European Directives ( OMFP 3055/2009 ) requires turnover to be disclosed at sales prices net of any trade discounts (hence the denomination Net Turnover for the item in the Income Statement): Net turnover comprises proceeds from sale of goods and rendering of services falling under the entity s current activity, after deduction of trade discounts and value added tax, as well as other taxes directly related to turnover. The use of the word apparently for the invoked exception may be surprising, but granting a trade discount actually presumes performing the transaction at a price lower than the one practiced, which entails recognition of the benefit at the actual level of the effect. The issue is similar to the one by which traders display a stroke through higher price, and underneath a lower one, presumably discounted, in order to attract clients. The issue should be seen as follows: at that time, depending on the market prerequisites, this is the prices used by the trader ( discounted price) and, consequently, the amount collected from the transaction should be recognized at that level. ISSN: ISBN:

3 To clarify the issue of trade discounts, by means of OMFP 3055/2009, since 1 January 2010 the lawgiver has introduced new tools for a proper disclosure of operating income: account 609 Received trade discounts, which is an expenditure account with passive accounting function disclosed in the income statement as a decrease of expenditure on inventories (those in Group 60), and account 709 Granted trade discounts, which is an income account with active accounting function that decreases turnover in the income statement. The clarification requirement came just due to the distorted disclosure of operating income, which was the managements direct target in fixing-up the companies results, as the image of the financial results was not monitored closely and, thus, not attributable to management. A series of errors in financial statements was represented by disclosure of trade discounts effects on financial results and not on operating income. The managers alibi was the lack of clear tools for charging trade discounts over operating income, although the content of the accounting regulations clearly required this; the inappropriate tools used were accounts 667 Expenditure on discounts and 767 Income from obtained discounts, which are intended solely to reflect financial decreases and affect the financial results. However, even after these changes, there are still outstanding issues is it correct to affect the results of the current year with the value of trade discounts received for inventories that have not been put into use as of the balance sheet date? The lawgiver relied on the short operating cycle of inventories, but the matching principle is obviously violated. The users needs for accounting information and for comparing the results and / or financial position both from one reporting period to another, as well as with other competing entities, has resulted in cutting the operating activities in reporting periods. For this reason, the company s life is divided into equal accounting periods financial years - which in most cases last for one year, but in practice they can last for one semester, quarter or even one month. The shorter the company s financial period, the more difficult it is to cut or assess accurately the revenues, expenses, assets and liabilities. A short period requires more estimates and reports, leading to more subjective judgments. When the financial year is represented by a short period, it becomes more difficult to apply the principles for connecting expenses to revenues and for revenue recognition. In other words, the accuracy of operating income decreases along with the shortening of the applicable financial period [1]. The matching principle was presented as follows in the Romanian accounting regulations Order of the Ministry of Public Finance no. 1752/2005 for approval of accounting regulations in compliance with European Directives (applicable until 31 December 2009): One must take into account the revenues and expenses related to the financial year, regardless of the date of collection or payment of such revenues and expenses. The essence of this principle consists in accruals accounting s main feature, which presumes that effects of transactions and events are recognized when they occur and not according to the collected or paid money equivalent [2]. In Romania, since 1 January 2010, OMFP 3055/2009 [3] nominates once more the tools that should facilitate the application of the matching principle: revenues accounts will also disclose those receivables for which invoices have not been issued yet (account 418 Clients invoices to be issued ), respectively expenditure or goods accounts will disclose those payables for which the invoice has not been received yet (account 408 Suppliers invoices not received yet ). In all cases registration in these accounts is made based on supporting delivery documents, respectively service rendering documents (for example, bills of acknowledgement, work status, etc.). These specifications explain some opinions expressed by certain accountants, who asserted that usage of accounts 408 Suppliers invoices not received yet and 418 Clients invoices to be issued represents a violation of accounting law [4], which, under art. 2, dictates a chronological disclosure of transactions in accounting. However, one should not forget the main purpose of accruals accounting, and thus we should consider the period in which expenses or revenues are taken on, according to events and / or contracts, as well as the date the transactions become formal. This section of the movie related to a company s life is a legal obligation: The balance sheet and the income statement shall be prepared under the legal provisions [5]. Companies must prepare annual financial statements, inclusively in case of mergers, scissions or cease of activity, according to the law [6]. Each of the sequence information (balance sheet ISSN: ISBN:

4 or annual financial statements) represents independent information from the point of view of allocation to a certain period. The matching principle (specialization or separation) involves connection of expenses to the revenues of the accounting period [7]. The matching principle achieves its real meaning when it comes to discuss about assessment of the period s results. These are assessed by considering all expenses and revenues related to the financial year, which brings into attention the issue of relationship criteria (connection). Thus, as opposite to cash accounting, we can define accruals accounting as follows: the effects of transactions and other events are recognized when transactions and events occur and not when cash or cash equivalents are collected or paid. From this point of view we could discuss about receivables and payables accounting ; consequently, we could say that revenues can be recognized only if the company has related receivables. This results from the application of prudence principle: a gain is recognized only if the revenue is certain (presuming that in previous periods related expenses have been incurred), because possession of a receivable is the best certainty criteria. On the other hand, accruals accounting is at the opposite pole when we speak about transaction accounting, i.e. registration of revenues and expenses according to the transaction that has generated them and not according to the period they have occurred, respectively an attachment of expenses to the generated revenues. This view is not incompatible with the split in annual accounting periods, considering that judgements are made globally and not with a logical development according to transactions. In practice, if we could detail a company s activity on transactions, one would observe that expenses related to transactions that are not finalized at year-end are included in the value of inventories or production in progress (current or investments). This is an Anglo-Saxon opinion (matching principle) and it introduces a cause-effect-type link in the accounting judgement, but without having a quasi-applicability. Two types of costs can be identified: product costs and period costs. Obviously, this classification does not denote that the later are not related to the production process, but they are not related directly to a certain product, transaction or turnover element. The costs of sold goods and commissions paid are only two clear examples of costs related to some revenues [8]. 3. Problem Solution As a solution to the impact on the matching principle, we suggest to give up the disclosure of subsequent trade discounts for materials within account 609 Received trade discounts and to introduce a new account within inventories group: account 309 Trade discounts related to inventories - materials, which should have a passive function and which should be credited with received trade discounts and debited at the end of the month based on a coefficient that should reflect the weight of received trade discounts in the total value of inventories received during the period or on stock, with the value of trade discounts related to used materials together with the impact on the specific operating expenses accounts. Thus, at the end of the period, the credit balance of account 309 Trade discounts related to inventories - materials would decrease the value of inventories in the balance sheet, while the level of expenditure on materials during the period is influenced only by trade discounts related to the used inventories. 4. Conclusion In the absence of treatments like those described in the previous paragraph, we observe that the lawgiver implicitly feeds creative accounting techniques. People would say: Accountants they can t do anything! We reach the same point Okay the result is the same, but the presentation is important i.e. the total impact obtained in comparison with a certain effort; thus, we discuss about performance and efficiency of developing economic transactions. We can take decisions only provided that we know the full background. And related to decisions, which is the impact of non-compliance with this principle on the decisions taken by accounting information users? Considering that in the notes to the financial statements we calculate certain efficiency ratios, we can say that these are directly influenced. Consequently, there is an impact on the decisions taken by investors, by various commissions set-up ISSN: ISBN:

5 for auctions in which the company is participating and where certain grades are attributed according to these ratios. Thus, the contract could be granted to the entity due to the beauty of performance ratios, such as liquidity, solvency, economic and financial profitability. References: [1] Niculae Feleagă, Ion Ionaşcu Tratat de contabilitate financiară, vol. I, Economică Printing House, Bucharest, 1998, pg [2] Dorel Mateş and contributors Contabilitatea financiară a societăńilor comerciale, Mirton Printing House, Timişoara, 2006 [3] *** Order of the Ministry of Public Finance no. 3055/2009 for approval of accounting regulations in compliance with European Directives [4] *** Law no. 82/1991 Accounting Law, republished in Romania s Official Gazette no. 454 of 18 June 2008 [5] *** Law no. 31/1990 Company Law, art. 177 [6] *** Law no. 82/1991 Accounting Law, art. 26 [7] Ovidiu Constantin Bunget Contabilitatea românească între reformă şi convergenńă, Economică Printing House, Bucharest, 2005, pg. 81 [8] Ovidiu Constantin Bunget Contabilitatea românească între reformă şi convergenńă, Economică Printing House, Bucharest, 2005, pg. 84 ISSN: ISBN:

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