Sales Discounts Definition, Accounting Treatment, Sample

A common example of the terms of sales discount is the ‘2/10 net 30‘ which means that the seller has offered the customer an opportunity to take a 2 percent discount if he or she pays the invoice within 10 days of the invoice date. Therefore, if the customer doesn’t pay within 10 days, the customer doesn’t get the discount and pays the full price of the goods or services within 30 days after the invoice date. Another common example is the ‘1/10 net 30‘, whereby the customer takes a 1 percent discount in exchange for paying within 10 days of the invoice date. Hence, if not met, the customer makes the full-price payment within 30 days after the invoice date. While it is acceptable to record and report discounts, returns and allowances within the sales revenue account–especially for very small businesses–doing so leads to the loss of valuable information and insights.

However, that is not the case, offering a sales discount reduces revenue and so is treated as a contra revenue rather than an expense. This means that a sales discount is not an expense but a contra-sales account. Therefore, companies that offer small discounts for a 10-day payment return are able to clear their accounts quickly.

Initial Recognition of Sales Transaction:

This line item is presented as a subtraction from the gross sales line item, and is intended to reduce sales by the amount of product returns from customers and sales allowances granted. It is followed in the income statement by a net sales line item, which is a calculation that adds together the gross sales line item and the negative amount in the sales returns and allowances line item. Hence, reporting a sales discount not as an expense but as a contra-revenue account allows the company to see the original amount of sales as well as the items that reduced the sales to the net sales amount.

Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. Because of the discount, the amount collected (Cash) is less than the amount due (Accounts Receivable). A manufacturer sells $1000 worth of products to its customer with credit terms of 1/10, n/30. Double Entry Bookkeeping is here to provide you with free online information to help you learn and understand bookkeeping and introductory accounting. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation. Someone on our team will connect you with a financial professional in our network holding the correct designation and expertise.

If Music Suppliers, Inc., offers the terms 2/10, n/30 and Music World pays the invoice’s outstanding balance of $900 within ten days, Music World takes an $18 discount. To record this payment to Music Suppliers, Inc., Music World makes a compound journal entry that decreases (debits) accounts payable for $900, decreases (credits) cash for $882, and increases (credits) purchases discounts for $18. On the income statement, contra-revenue accounts are reported separately from the gross sales the difference between a cash flow forecast and a cash flow statement revenue to show the discounts, allowances, and returns that reduced the original total value of the sale to the net amount. This is more informative for the reader of the financial statements rather than when only the company’s net balance is reported on the income statement. With the use of a contra-revenue account, the reader of the income statement will be able to differentiate between the original amount of sales revenue generated, the sales reduction, and the resulting net amount.

  • For example, terms of “1/10, n/30” indicates that the buyer can deduct 1% of the amount owed if the customer pays the amount owed within 10 days.
  • Let’s look at what is considered an expense in accounting in order to answer this.
  • Sales discounts are recorded as a reduction in revenue under the line item called accounts receivable.
  • This entry will recognize the sale amount $25k as well as recognizing the account receivable amount $25K in the income statement.
  • The sooner a company receives cash after providing a good or service, the better off it is financially.

Due to its high cost, it can be seen that sales discounts should be offered sparingly. The full amount owed by the customer is shown as a balance sheet asset (accounts receivable) and included as revenue in the income statement. The sales discount is based on the sales price of the goods and is sometimes referred to as a cash discount on sales, settlement discount, or discount allowed.

What are sales discounts?

A contra revenue account allows a company to see the original amount sold and to also see the items that reduced the sales to the amount of net sales. In this instance the accounts receivable is cleared by the receipt of cash and no sales discount is recorded. However, if a company has not been prompt in paying their suppliers, then offering sales discounts can help alleviate the situation because now both parties are being treated equally. In other words, contra sales revenue is the difference between gross revenue and net revenue. Sales Returns contra revenue account records the value of a sales deduction attributable to goods returned by buyers in exchange for a refund. It effectively costs the business 46.72% to offer sales discounts to the customer.

Again, the company’s management will see the original amount of sales, the sales discounts, and the resulting net sales. Assume, Company ABC sold $100 worth of goods to a customer who will pay the invoice at a later date. Company ABC will record this transaction as a debit of $100 to accounts receivable and a credit of $100 will be made to the sales revenue account. This line item is the aggregation of two general ledger accounts, which are the sales returns account and the sales allowances account. Both of these accounts are contra accounts, which means that they offset gross sales.

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This is why Sales Returns and Allowances, as well as Sales Discounts, are reported separately from the gross sale as contra-sale accounts on the income statement above. A sales discount also known as a cash discount or early payment discount is the reduction that a seller gives to a customer on the invoiced price of goods or services in order to incentivize early payment. That is, the seller gives the customer an opportunity to pay a lesser amount for the goods or services that are purchased when the customer pays within the stated discount periods.

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They are the expenses account which is reported in the income statement for the period that the allowance or discount occurs. A Cash or Sales discount is the reduction in the price of a product or service offered to a customer by the seller to pay the due amount within a specified time period. Sales discounts are otherwise called cash discounts or early payment discounts.

Expenses and revenues are usually reported in a company’s income statements. Hence, a company’s net profit is the total revenue generated minus its expenses. That is, in order to calculate the profitability of a business, expenses are deducted from revenue.

As seen in the income statement above, the sales discount is a contra-revenue account and not an expense. As a contra revenue account, the sales discount appears on the income statement as a $5,000 reduction from the gross revenue of $100,000 that ABC Ltd reported, which results in net revenue of $95,000. The discount is recorded in a contra revenue account which is offset against the revenue account in the income statement. If the customer pays within the 10 days and takes the sales discount of 50, then the business will only receive cash of 1,950 and accounts for the difference with the following sales discounts journal entry. Sales discounts are recorded in a contra revenue account such as Sales Discounts.

Most businesses do not offer early payment discounts, so there is no need to create an allowance for sales discounts. A company may choose to simply present its net sales in its income statement, rather than breaking out the gross sales and sales discounts separately. This is most common when the sales discount amount is so small that separate presentation does not yield any material additional information for readers. The amount of sales discount is deducted from the gross sales to calculate the company’s net sales and recorded in a separate sales discount account. Let’s say Company ABC offered the customer a sales discount term of ‘2/10 net 30’.

Sales or Cash Discounts are properly recorded and shown in the financial statements. Trade discounts are not recorded as sales discounts and deduct directly at the time recording sales. Sales discounts are recorded as a reduction in revenue under the line item called accounts receivable. An example of a sales discount is when a buyer is entitled to a 1% discount in exchange for paying within 10 days of the invoice date, rather than the normal 30 days.

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