[Andy]

To keep things simple, let me quote the relevant part in IFRIC Update (November 2004) here:
“IAS 2 Inventories: Discounts and rebates
The IFRIC considered three related questions on the application of IAS 2 Inventories that had been referred to it by the Urgent Issues Group (UIG) of the Australian Accounting Standards Board:
(a) whether discounts received for prompt settlement of invoices should be deducted from the cost of inventories or recognised as financing income.

…..

On (a), the IFRIC tentatively agreed that settlement discounts should be deducted from the cost of inventories. Because the requirements under IFRSs were sufficiently clear, the IFRIC tentatively agreed that the matter should not be added to the agenda.”

Please note that this accounting treatment is not explicitly stated in IAS 2 and that’s why interpretation or clarification is required. I’m afraid no further reference can be provided.

Thank you.

p.s. I have studied US GAAP accounting at a basic level and this is the generally accepted approach under U.S. GAAP.

[Andy]

Thank you for your advice.
In fact, I have stated the source in my post. The links are given below (thanks to Google):
https://www.ifrs.org/Updates/IFRIC-Updates/2002/Documents/aug02.pdf
https://www.ifrs.org/Updates/IFRIC-Updates/2004/Documents/nov04.pdf

[Andy]

I’m sorry if I have offended you; that was not my intention. I asked you the question because I don’t know the answer. Your are right. I should have given you ALL the appropriate facts accompanied by ALL the appropriate descriptions in my first post. The fact is I asked the same question in another forum (in Hong Kong) and some said yes and some said no. I am confused. Someone said yes gave the reason (stated in my second post) and so i repeated it here.

Thank you for giving me the answer.

[Andy]

But according to IAS 16.23, the cost of an item of property, plant and equipment
is the cash price equivalent at the recognition date. If we do not deduct cash discount, the cost will be higher than the cash price equivalent (the amount we actually pay).

[Andy]

You might be interested to know that this question was actually asked in GCE A-level Accounting exam. (The original question asked students to analyse the impact on liquidity and profitability of the two forms of finance:debentures and shares.)

[Andy]

Thank you for your explanation. So should I include your comment in the answer if this question is asked in an exam? Or should I just give a simple answer?

[Andy]

Thank you.

[Andy]

Thank you for giving me a detailed answer. My two examples are used to demonstrate that acceptance of a wrong concept will lead to a strange (or absurd) result.

First, let me repeat what I said in my first post: “goods purchased are assets (not expenses) until they are sold”. When inventories (goods purchased) are SOLD, the carrying amount of those inventories shall be recognised as an expense in the period in which the related revenue is recognised. The keyword here is “SOLD”.

Some people get purchases and cost of goods sold mixed up. The cost of goods sold is an expense but purchases may not be the same as cost of goods sold. Consider the following formula: (to keep things simple, let’s ignore opening inventory for the moment)

cost of goods sold = purchases – closing inventory

It is very strange or even absurd if purchase returns will increase the profit. If this is true, a trader can return goods to the suppliers to increase the profit. There is no need to sell goods at a price higher than the cost to make profit. In fact, if we return goods then the net PURCHASE is reduced but the cost of goods sold remains unchanged. Why? Because the closing inventory is also reduced by the same amount as goods returned. And from the above formula, it is not difficult to see why the cost the goods sold (and hence the profit) is the same. In other words, we cannot increase the profit by just returning goods. This makes sense.

Some may argue that when all goods purchased are sold, there is no inventory. In this case, purchases will be the same as cost of goods sold. Let’s consider my second example. I will use the figures given by you for illustration purpose.

“Consider this: suppose the business buys goods for 20,000 and sells them for 30,000. There is a profit of 10,000 and capital therefore increases by 10,000.
However, suppose it turns out that the owner took goods that had cost 1,000. In this case there are certainly drawings of 1,000 (and this reduces the capital). However since the cost of the goods that were sold are now only 9,000, it means that the profit is actually 11,000 – 1,000 higher than before, which increases the capital).”

There is a careless mistake in the last sentence. I assume that you mean the cost of the goods that were sold are now only 19,000 (not 9,000). So you said “the profit is actually 11,000 – 1,000 higher than before, which increases the capital”. This is also incorrect. Why? It may be easier to understand if we assume 20 units of goods are bought at 1,000 each. So the total cost is 20,000 and the unit selling price is 1,500. If the owner took goods that had cost 1,000 (i.e. one unit), the cost of goods that were sold are now 19,000. But the sales revenue is not 30,000 any more because there are only 19 units of goods available for sale. That means the sales revenue is 19 x 1,500 = 28,500 only and therefore the profit is 28500 – 19000 = 9500 (not 1,000 higher but 500 lower than before). So in addition to a decrease in capital because of drawings, the business earns 500 less. (one unit of goods is taken by the owner and the related profit is forgone.)

I hope my explanation is clear. Thank you again for your attention.

[Andy]

Thank you for your reply.

I found the answer to my question in your F3 free lecture (chapter 2 part a). When you (is that you?) talked about the dual effect of a transaction (transaction d: buys goods for resale on credit), you said the inventory has gone up (asset increases) and the business owes an amount to the person we bought the goods from (liability increases). That’s the answer I want.

What I don’t understand is that why treat goods bought as expenses in the first place and when we find that the goods are unsold at the end of the period we change them back to asset. I just want to say that purchase of goods (per se) will not decrease the profit (or equity). If we follow the wrong concept (i.e. purchase decreases the profit and the equity), we may draw very strange conclusion. e.g. purchases returns will increase the profit (we can return goods to suppliers to make profit???), drawings of goods will not decrease equity (Is that true?)

Thank you.

[Andy]

Thank you so much but you haven’t answered my question. I’d like to know the dual effect of a typical transaction, which is credit purchase of goods.
There are two different answers:
A. equity decreases and liability increases
B. asset increases and liability decreases

Which answer is correct, A or B?

And if the correct answer is A, can you explain why asset does not increase? Inventory (unsold goods) is an asset, isn’t it?

[Author]

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