This week%u2019s discussion focuses on Activity 4-2 located on page 164 of your

Question

This week%u2019s discussion focuses on Activity 4-2 located on page 164 of your textbook which reads as follows:

The Encore Video Store Co. is owned and operated by Sergio Alonzo. The following is an excerpt from a conversation between Sergio Alonzo and Suzie Engel, the chief accountant for The Encore Video Store:

Sergio: Suzie, I%u2019ve got a question about this recent balance sheet.

Suzie: Sure, what%u2019s your question?

Sergio: Well, as you know, I%u2019m applying for a bank loan to finance our new store in Cherokee, and I noticed that the accounts payable are listed as $120,000.

Suzie: That%u2019s right. Approximately $100,000 of that represents amounts due our suppliers, and the remainder is miscellaneous payables to creditors for utilities, office equipment, supplies, etc.

Sergio: That%u2019s what I thought. But as you know, we normally receive a 2% discount from our suppliers for earlier payment, and we always try to take the discount.

Suzie: That%u2019s right. I can%u2019t remember the last time we missed a discount.

Sergio: Well, in that case, it seems to me the accounts payable should be listed minus the 2% discount. Let%u2019s list the accounts payable due suppliers as $98,000, rather than $100,000. Every little bit helps. You never know. It might make the difference between getting the loan and not.

How would you respond to Sergio Alonzo%u2019s request?

Explanation / Answer

In a principles course you learn the gross method for purchase discounts (basically that is recording the discount once you've actually paid within the discount period).

Here you would tell Sergio that you cannot restate the account based on the principle of faithful representation: the accounts should reflect the historical cost of the asset (liability) rather than what we think or even what the market says the asset (liability) is worth.

The net method of accounting for purchase discounts does allow for the inventory and the associated payable to be recorded net of the discount at the inception of the sale.

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