What about inventories received for free?
Well, it depends.
If a government (including governmental agencies) donated you some inventories, then you should apply the standard IAS 20 Accounting for Government grants and Disclosure of government assistance.
f you received some units of inventories for free as a “gift” with your purchase, then you should apply the standard IAS 2 – i.e. measure inventories at cost.
For example, you purchased 1 000 units at CU 2/unit and received 50 units for free, then you record 1 050 units at CU 2 000, i.e. CU 1,90/unit.
I have also seen that some companies record free items at their fair value while a credit entry goes in profit or loss (as an income). However, this approach is not supported by IFRS.
In any case, you should always seek the substance of a transaction and then make appropriate decision.
When you should NOT discount your goods or services
Let’s take a different angle of looking at discounts. My friend, Prof. Robin Joyce helped me with that.
Discounts represent a very powerful selling tool, but at the same time, they are like marketing’s nuclear weapon.
Why?
The reason is that discounts can lower price perception permanently or make your product a commodity.
It means that clients will see no difference between your product and other products – they will just buy the cheapest (not necessarily the best).
What do discounts do to your profit? Do you really need to discount your products or services in order to increase your profits?
If you sell some tangible products, then you need to know the exact financial impact of your planned discounts on sales and the net profit.
The following table sums it up (read the explanation below the table):
Table of discounts and margins
This table shows you how many additional items you should sell at your present profit margins, if you want to keep the same profit.
For example, if you are making 80% margin (top row), and you provide a discount of 20% (side column), you need to sell 33% more units to get the same financial result as without giving a discount.
Putting some numbers to it:
Let’s say you sell a product for CU 100 with 80% margin, therefore its cost of sale is CU 20. You sell normally 100 units, therefore your gross profit is CU 80*100 units = 8 000.
You’d like to give a discount of 20%. Looking at a table above, you need to sell 33% more units than before to have the same effect.
For verification, your new discounted sales price is CU 80, therefore your gross profit with 33% more units sold is CU 60 (80-20) * 133 units = 7 980 (Cu 20 is a rounding difference).
This table assumes that you provide discounts for all your units sold, not just some of them (in this case, you would need to adjust the calculation).
What are the conclusions?
You need to know your gross margin before considering a discount.
You need to know how many additional units you need to sell after discount to keep the profit. And, are you able to do so? Will your customers really buy 33% more with 20% discount?
If you operate with low margins, you cannot afford any discount. For example, if you operate at 10% margin, you cannot give away any discount without hurting your gross profit. You simply cannot sell enough items to pay for it.
It’s your turn now! If you have any questions or concerns with regards to discounts and their accounting, please let me know in the comments below this article. Thank you!
By IFRS
By IFRS
Connecting the ideas...
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