Accounting for Sales Discounts

What is Accounting for Sales Discounts?

Accounting for Sales Discounts refers to the financial recording of reducing the sales price due to early payment. The sales discounts are directly deducted from the gross sales at the time of recording in the income statement. In other words, the value of sales recorded in the income statement is the net of any kind sales discount – cash or trade discount.

Explanation

Usually, sellers offer reductions in the selling price of a product or service to encourage early or bulk payment from the purchasers. These reductions are termed as a sales discount. A sales discount’s objective may also be to support the seller’s need for liquidity or to bring down the amount of outstanding accounts receivables as of any particular date. The amount of sales discount is calculated as a particular percentage of the sales price and can be in the form of cash or trade discountTrade DiscountThe reduction in list price allowed by a supplier to the consumer while selling the product in bulk quantities is referred to as a trade discount. It is carried out in order to boost the sale of the business.read more on sales, discount allowed, or settlement discount. Trade discounts are those sales price reductions offered to wholesalers when they purchase in bulk, while cash discount refers to a reduction in sales price offered to customers due to early payment.

Examples

Example #1

Let us take the example of SDF Inc., who sold merchandise to ASD Inc. on January 31, 2019, at a total sales price of $50,000. ASD Inc. has been given 30 days to make the payment. But if the customer pays the amount within 10 days, it will be offered a discount of 2% on the sales price. Prepare the journal entries for recording the transaction if:

  1. ASD Inc. makes the payment on February 20, 2019, i.e., after the discount period’s expiry.
  2. ASD Inc. makes the payment on February 08, 2019, i.e., within the discount period.

a) In this case, the journal entries would be as follows:

Accounting for Sales Discounts Example 1.jpg

b) In this case, the journal entries would be as follows:

Accounting for Sales Discounts Example 1-1

Example #2

Let us take the example of DFG Inc., who sold merchandise to SWE Inc. on March 31, 2019, for a sales price of $100,000 with the terms – 10%, 5/10, n/30. Prepare the journal entries for recording the transaction if:

  1. SWE Inc. makes the payment on April 15, 2019, i.e., after the expiry of a 5% discount.
  2. SWE Inc. makes the payment on April 07, 2019, and avails an additional 5% discount.

In both cases, the customer enjoys a basic discount of 10% on the sales price of $100,000, i.e., $10,000. So, effectively the sales price will be $90,000.

a) In this case, the journal entries would be as follows:

Accounting for Sales Discounts Example 2

b) In this case, the journal entries would be as follows:

Accounting for Sales Discounts Example 2-1

Accounting for Sales Discounts on Income Statement

The accounting of sales discounts on the income statement is fairly simple. The amount of sales discounts is deducted from the number of gross sales or revenue recognized. It is reported as a separate line item as “net salesNet SalesNet sales is the revenue earned by a company from the sale of its goods or services, and it is calculated by deducting returns, allowances, and other discounts from the company's gross sales.read more” on the income statementIncome StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.read more. The net sales refer to the actual amount of revenue earned during the period. In the income statement, it is recorded, as shown below:

Accounting for Sales Discounts (Income Statement)

Journal Entries of Accounting for Sales Discounts

The two journal entries, as shown below:

  • At the time of origination of the sales, the seller has no idea whether the buyer will avail of the sales discounts by paying off the outstanding amount early or making the full payment on the due date. In such a scenario, the seller will record the entire sale as per the invoice without considering any sales discount.

Journal Entries 1

As a result of the above transaction, the outstanding amount of accounts receivable account and sales increased.

  • If the customer wants to avail of the discount offered on sales items and pays within the discount period, the business will only record lower cash than the sales price due to the discount.

Journal Entries 2

As a result of the above transaction, the outstanding amount of accounts receivableAccounts ReceivableAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet.read more is reduced by increasing the aggregate value of cash and sales discount.

Advantages

  • The customers can buy the goods at slightly get lower prices.
  • Sales discounts result in early payments that support the liquidity position of the seller.
  • It results in a reduction of outstanding accounts receivable.

Disadvantages

  • The seller has to bear the brunt of lower revenue due to sales discounts. As such, sales discounts can also be seen as an extra cost for the seller.
  • If the cost of funds for the early payment is higher than the sales discount, then the buyer will effectively lose money on the transaction.

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