Question 3.6: Retailer Domestic Ltd sells household electrical appliances....
Retailer Domestic Ltd sells household electrical appliances. It pays its sales staff a commission of 2% of sales revenue generated. Total sales revenue for last year amounted to $300,000. This will mean that the commission to be paid in respect of the sales for the year will be $6,000.
However, by the end of the year, the amount of sales commission that had actually been paid to staff was only $5,000. If the business reported just the amount paid, it would mean that the income statement would not reflect the full expense for the year. This would contravene the matching convention, because not all of the expenses associated with the revenue of the year would have been matched in the income statement. Also, the justification for the commission is clear (better than probable), and it is measurable with accuracy. So the adjustment needed is as follows:
- Sales commission expense in the income statement will include the amount paid plus the amount outstanding (i.e. $6,000 = $5,000 + $1,000).
- The amount outstanding ($1,000) represents an outstanding liability at the end of the year and will be included under the heading accrued expenses, or ‘accruals’, in the statement of financial position. As this item will have to be paid within 12 months of the year-end, it will be treated as a current liability.
- The cash will already have been reduced to reflect the commission paid ($5,000) during the period. These points are illustrated in Figure 3.2.
When the outstanding sales commission is paid (probably in the next quarter):
- cash will be reduced, and
- the amount of the accrued expense will be reduced/eliminated.
accrued expenses Expenses which are outstanding at the end of the accounting period
