Discounts may be offered on sales of goods to attract buyers. Discounts may be classified into two types:
Trade Discounts: offered at the time of purchase for example when goods are purchased in bulk or to retain loyal customers.
Cash Discount: offered to customers as an incentive for timely payment of their liabilities in respect of credit purchases.
Trade Discount
Trade discounts are generally ignored for accounting purposes in that they are omitted from accounting records.
Therefore, sales, along with any receivables in the case of a credit sale, are recorded net of any trade discounts offered.
Example
Bike LTD as part of its sales promotion campaign has offered to sell their bikes at a 10% discount on their listed price of $100.
Sales will be recorded net of trade discount, i.e. $90 per bike.
Cash Discount
Cash discounts result in the reduction of sales revenue earned during the period. However, not all customers may qualify for the cash discount. It is therefore necessary to record the initial sale at the gross amount (after deducting any trade discounts!) and subsequently decreasing the sale revenue by the amount of discount that is actually allowed.
Following double entry is required to record the cash discount:
|
Debit |
Discount Allowed (income statement) |
|
Credit |
Receivable |
Debiting discount allowed ledger has the effect of reducing gross sales revenue by the amount of cash discount allowed. Consequently, receivables are credited to reduce their balance to the amount that is expected to be recovered from them, i.e. net of cash discount.
Example
Bike LTD as part of its sales promotion campaign has offered to sell their bikes at a 10% discount on their listed price of $100. If customers pay within 10 days from the date of purchase, they get a further $5 cash discount. Bike LTD sells a bike to XYZ who pays within 10 days.
Before we proceed with the accounting entries, it is necessary to first distinguish between the two types of discounts being offered by Bike LTD. The 10% discount is a trade discount and should therefore not appear in Bike LTD’s accounting records. The $5 discount is a cash discount and must be dealt with accordingly.
The initial sale of the bike will be recorded as follows:
|
Debit |
XYZ (Receivable) |
$90 |
|
Credit |
Sales |
$90 |
As XYZ qualifies for the cash discount, the following double entry will be required to record the discount allowed:
|
Debit |
Discount Allowed (income statement) |
$5 |
|
Credit |
XYZ (receivable) |
$5 |
The above entries have resulted in sales of Bike LTD being reduced to $85 (100-10-5). The receivable from XYZ has also been reduced to this amount effectively.