Discounts may be offered by suppliers 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.
Accounting Treatment for Discounts on Purchases
Trade Discount
Trade discounts are generally ignored for accounting purposes in that they are omitted from accounting records.
Therefore, purchases, along with any payables in the case of a credit purchase, are recorded net of any trade discounts offered.
Example
BMX LTD as part of its purchases promotion campaign has offered to sell their bikes at a 10% discount on their listed price of $100.
Purchases from BMX LTD will be recorded net of trade discount, i.e. $90 per bike.
Cash Discount
Cash discounts result in the reduction of purchase costs during the period. However, not all purchases may qualify for the cash discount. It is therefore necessary to record the initial purchase at the gross amount (after deducting any trade discounts though!) and subsequently decreasing purchases by the amount of discount that is actually received.
Following double entry is required to record the cash discount:
|
Debit |
Payable |
|
Credit |
Discount Received (income statement) |
Crediting discount received has the effect of reducing gross purchases by the amount of cash discount received. Consequently, payables are debited to reduce their balance to the amount that is expected to be paid to them, i.e. net of cash discount.
Example:
BMX LTD as part of its purchases 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 purchases a bike from BMX LTD and pays within 10 days of the date of purchase.
Before we proceed with the accounting entries, it is necessary to first distinguish between the two types of discounts being offered by BMX 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 purchase of the bike will be recorded as follows:
|
Debit |
Purchases |
$90 |
|
Credit |
BMX LTD (Payable) |
$90 |
As Bike LTD qualifies for the cash discount, the following double entry will be required to record the discount received:
|
Debit |
BMX LTD (Payable) |
$5 |
|
Credit |
Discount Received (income statement) |
$5 |
The above entries have resulted in purchases of Bike LTD being reduced to $85 (100-10-5). The payable to BMX LTD has also been reduced to this amount effectively.