CHAPTER 04
ACCOUNTS CURRENT AND AVERAGE DUE DATE
WHEN it is agreed that interest be charged in respect of transactions between parties it is usual, in order to facilitate calculations, to have a special column ruled adjacent to the ordinary column, on each side of the Ledger, this being purely 'Memorandum.' Such additional columns are employed merely on account of their usefulness in the calculation of interest, and having provided the amount thereof the columns have fulfilled their function. Hence the entry of interest into the ordinary columns of the Ledger must be posted to Interest Account, either through the Journal, or if the number of transactions of this kind should warrant it, through an Interest Journal or Day Book.
An Account Current, then, is a statement in account form of transac- tions of one person with another, duly set out in chronological order, with additional columns for the purpose of computing interest allowed or received, the net balance of which will be entered to the credit or debit of the account itself.
Before the methods employed in accounts current are dealt with, it will be necessary to observe the following points:
1. The Account, save for Interest, will be an ordinary account, but just as Bank Statements may contain the entries reverse to the sides in the bankers' book, i.e. to correspond with the entries on the customer's Statements, so the Account Current may, when rendered to a party, be reversed to correspond with the entries in the books of the person to whom it is sent.
Thus 'Jones in Account Current with Brown' would represent the state of account of Jones in Brown's books; in other words, Jones is the accounting party, so that his account will be in debit for goods sold to him, charges, etc., and in-credit for payments, discounts thereon, allowances, etc..
If, for the convenience of Jones, these sides are reversed, the heading will be 'Brown in Account Current with Jones', and the entries will correspond to, and be on the same side as, those appearing in Jones's Ledger; that is, Brown will be in credit for goods he has supplied to Jones, and in debit for payments, discounts thereon, allowances, etc.
2. In calculations of interest, if computed according to the number of days, the opening date, if it is the date on which the balance, if any, is brought down will be included, but if it is the date of the first transaction it will be excluded.
3. Particular care is required in dealing with bills of exchange and forward-dated sales, as the due date of the bill and the forward date of the sale are the material dates for the purpose of interest.
The mathode adopted vary, and from an examination point of view it is advisable to be quite clear on one method and ignore the others.
The various methods are:
First Method
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Each item is considered individually, and the number of days from the date listed for each item to the end of the period is determined. Interest is then calculated at the agreed-upon rate for the appropriate number of days.
Second Method
A modification of the above method is to employ the products system, i.e. instead of making separate calculations, each item is multiplied by the number of days from its date to the end of the period, and one interest calculation only is made on the net products for one day. It should be clear to the student that if there is interest on £150 for 10 days, this, when made into a product and treated by the products method, will be-Interest on £150x 10-£1,500 for one day: and this principle is employed herein.
Third Method
The other method of importance is the Époque method. Broadly speaking, the procedure is the reverse of those already explained. Interest is computed from the commencement of the period to the date of each item. Thus no Interest must be charged on the OPENING BALANCE,' but interest for the whole period of the account will be charged on the CLOSING BALANCE.'
Where interest is computed at a higher rate for debits than credits, or vice versa, there will be two calculations, one for the total debits and another for the total credits. This applies to all the above methods.
RED INK INTEREST
Where transactions are passed through an Account Current it is essential to compute interest from the due date, and not from the date of entry. As has been seen, an invoice may be dated forward, and, analogous to this, a bill of exchange may be payable at a future date. No particular difficulty is likely to arise so long as such future date falls within the period under review. Where, however, such due date occurs after the period of the account has terminated, the intervening time (i.e. between the close of such period and the due date) must be brought into consideration.
1. Ordinary Method. Where an entry is made against the customer, and the due date arises after the close of the period, it can be seen that not only should no interest be charged, but CREDIT given for the time elapsing from the close of the period to the due date, because the item debited will be brought down as a balance for the new period, and consequently interest which should run from the due date will be charged as from the start of the new period.
The converse applies where the customer accepts (i.e. remits) a bill of exchange, due after the period in question has closed. The opening
'Debit balances are here assumed. On the same principle interest will be credited for credit
balances.
ACCOUNTS CURRENT AND AVERAGE DUE DATE
balance for the new period on which interest is calculated, will be unduly small. Accordingly it will be necessary to charge interest on the bill from the date of the close of the period to the due date of the bill.
Thus the interest will be normally on the reverse side to the relevant item, but it is customary to show it in red ink on the same side, to denote that it really belongs to the opposite side, and to connect it with its appropriate item. These red ink entries will be calculated separately from the others: that is, red ink entries on the debit side will be counted as credits, and vice versa, and if there are a number of red ink entries on both sides the balance only may be used for the interest calculation, provided that the rate of interest for debits and credits is the same.
2. Epoque Method. Under the Epoque method, interest must be charged on the bill from the commencement of the period in which the bill is remitted to the due date of the bill, since the interest calculation for the whole period is made on the closing balance, and not on the opening balance, which is understated by the amount of the bill. Thus no red ink modifications are called for. The same principle applies to forward dated sales.
In order to prevent confusion it is submitted that it is preferable to avoid red ink interest, and always to insert the interest upon its correct side. The rules may be formulated thus:
1. Ordinary Method. Where an entry is made within the period in question but having a due date SUBSEQUENT to the close of such period, interest must be calculated for the time elapsing between the close of the period and the due date of the transaction, and shown on the opposite side to the principal entry, or, if the red ink principle is to be followed, the interest entry will be in red ink on the same side as the principal entry, to denote that its true side should be on the reverse of the account.
Alternatively, interest may be computed from the nominal date (on the usual lines) and shown in the ordinary way, and on the opposite side of the account an entry for interest may be made, for the length of time elapsing between nominal date. and due date.
Illustration 1
A owes B on 1st January 19.., £300 and on 31st March he remits a bill of exchange for £120 (seven months' date). Interest is charged at 5 per cent per annum (calculated in months), the Account Current running to 30th June 19...
It will be seen that the bill is not due till the end of October, and therefore the period elapsing from the end of June is four months; hence interest on £120 for four months will be debited to the account.
The various alternative methods which may be used are shown on pp. 0405 to 0406.
2. Époque Method. It must carefully be observed that under the Époque method the interest on the bill is calculated from the commence-- ment of the period to the due date of the bill, and not from the date of the giving of the bill. Thus, in the above case, 10 months is the period upon which the calculation is based.
The same principle applies when items are charged within the period of the Account Current, and the due date falls after the end thereof:
Ilustration 2
£
200
On 1st January 19... A owes B
50
1st March 19.., A remits cash
"
1st April 19... A buys goods from B (due date. 1st September) 1st May 19... A remits an 8 months' bill
120
100
Show Account Current rendered by B to A for half-year to 30th June 19. calculating interest at 5 per cent per annum. See Account (1) on p. 0407.
Alternatively, the Account Current may be stated by taking the nominal date of the goods and the bill as the true date and calculating the number. of months from the nominal date to the actual dates on the contra, as in Account (2) on p. 0407, i.e.:
(a) Instead of calculating red ink interest on the bill for six months, interest will be calculated as if the bill were due on the date given, i.e. 1st May-two months interest and contra interest for the period of the bill, i.e. eight months; thus the difference contra' is six months as in the previous example (see items q and r in Account (2) and b in Account (1)). (b) Instead of calculating red ink interest on the goods for two months, interest will be calculated as if the invoice for the goods were dated 1st April-three months interest and contra interest for the period elapsing between 1st April and 1st September-five months; thus the difference is two months as in the previous example (see items x and y in Account (2) and a in Account (1)).
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The preceding examples have been worked on the ordinary and conven tional rules, but from a purely academic point of view where Red Ink interest occurs the correct procedure is to bring the interest down to the following period in the Interest column, and not to add it to the principal (or deduct as the case may be), because the result should be exactly the same as that where cash is paid on the due date of the bill without the intervention of any bill transaction. The interest calculation in the period in which the bill matures should not be affected by the bill transaction.
Illustration 3
A owes B £300 on 1st January 19.. in respect of which debt B receives at 7 months' bill for £120. Assuming no further transactions occur, and that the bill is met at its due date, show the Account Current in the books of B to 30th June 19.., and 31st December 19... taking interest at 5 per cent per annum.
(1) The method academically correct is given in the first example on p.
0408.
(2) The Account Current drawn up under any of the methods indicated before would show a balance on 31st December 19.., of £194.24, as shown in the second example on p. 0408,
The difference is accounted for by the balance at 30th June being brought down as £189-50, as distinct from £187-50, that is £2 at 5 per cent for half-year = £0.05.
Change in Rate. It frequently occurs that during the period under review the rate of interest is changed. In this event, probably the simplest method is to strike a balance of the principal on the date that the rate changes, calculate the interest to that date, and then calculate interest at the new rate on the balance of the principal to the end of the period. Care should be taken, of course, not to transfer the interest to the principal column before the end of the complete period.
Illustration 4
19..
Jan.
1 Balance due to Brown.
Mar. 31 Jones remits cash to Brown
Apr. 14 Brown sells goods to Jones (dated 15th May)
May 1 Jones sells goods to Brown
£
400
250
50
20
Interest to be calculated at 5 per cent per annum up to the 6th April, when it changes to 6 per cent per annum.
Show Account Current to 30th June, calculating in days. The Account Current is given on p. 0409.
Periodic Balance Method. Under this method interest is reckoned on the balance (if any) from the commencement of the period until the date of the next transaction, when the revised balance is struck and interest is computed on it, in its turn, from such date to the date of the next transaction, this process being continued throughout the period of the
account.
Thus interest is reckoned in stages, each being measured by the length of time the balance remains unchanged.
This method is particularly suitable for interest calculations in banking accounts, but it may also be applied to ordinary accounts. Its use will necessitate alteration in the form of the Account Current inasmuch as it entails the striking of a new balance on the occasion of any transaction relating to the account. It must be clearly observed that where in a banking account a higher rate of interest is charged on overdrafts than is allowed on amounts in credit this is quite different from the system of charging one rate on all debits and allowing another on all credits, because in calculating Bank Interest the TEMporary Balance is the material
factor.
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AVERAGE DUE DATE
This may be defined as the mean or equated date on which one payment may be made in lieu of several payments due on a series of dates.
It is used in connection with the settlement of contra accounts; accounts which are to be settled by a series of bills; the calculation of interest on partners' Drawings Accounts; the piecemeal realization of assets during a partnership dissolution; and other transactions of a similar nature.
The method of arriving at the average due date is as follows:
1. A certain convenient basic date is taken as a starting point from which all calculations have to be made. This starting point should prefer- ably be the due date of the earliest transaction.
2. The number of days (or months) that the due date of each transac- tion is distant from the basic point must then be ascertained.
3. Each item (usually taken to the nearest f) is multiplied by its distance (measured in terms of days or months) from the basic point.
4. The products are totalled and divided by the total of the various amounts.
5. The result is the number of days (or months) that the average due date is distant from the chosen basic date.
