Sales discounts are not expenses so they do not have any effect on assets or liabilities, only revenue that will reduce net income. Sales discounts also have a secondary effect on companies because it allows them to “control” their accounts receivable balances by knowing when they will receive payment. Sales discounts may induce a company to encourage prompt payment from its customers.
Assuming the credit terms are 2/10, n/30 and Music World pays the invoice within ten days, the payment equals $882, an amount calculated by subtracting $18 (2% of $900) from the outstanding balance. To record this payment from Music World, Music Suppliers, Inc., makes a compound journal entry that increases (debits) cash for $882, increases (debits) sales discounts for $18, and decreases (credits) accounts receivable for $900. Sales Discounts is a contra revenue account that records the value of price reductions granted to buyers in order to incentivize early payments. Examples include Net D cash discounts like 2/30 Net 60, where a full invoice payment is due in 60 days but a buyer will receive a 2% discount in case of an early settlement within 30 days.
- Another common sales discount is “2% 10/Net 30” terms, which allows a 2% discount for paying within 10 days of the invoice date, or paying in 30 days.
- 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.
- Sales Discount refers to the reduction in the amount due from a customer as a result of early payment.
- Again, the company’s management will see the original amount of sales, the sales discounts, and the resulting net sales.
- Most businesses do not offer early payment discounts, so there is no need to create an allowance for sales discounts.
Businesses offer a sales discount in order to incentivize their buyers or customers to pay invoices in a timely manner. This is because when a company’s invoices are settled early, the amount of time that the business is extending credit will be reduced which in turn improves cash flow and also reduces the risk of invoice aging and bad debt. For the recent year, the company had gross sales of $510,000 and had sales discounts of $4,000 and sales returns and allowance of $5,000. Sales returns and allowances is a line item appearing in the income statement.
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Let’s look at what is considered an expense in accounting in order to answer this. The opposite of the revenue contra accounts Sales Discounts, Returns and Allowances are expense contra accounts Purchase Discounts, Returns and Allowances. A discount received is the reverse situation, where the buyer of goods or services is granted a discount by the seller. The examples just noted for a discount allowed also apply to a discount received.
The seller usually states the standard condition (terms of sales discount) at which the discount may be taken by the customer in the header bar of the invoices issued. A contra sales revenue account–such as Sales Allowances, Returns and Discounts-has a debit balance because it is contrary to the credit balance of a regular Sales Revenue account. A discount allowed is when the seller of goods or services grants a payment discount to a buyer. It may also apply to discounted purchases of specific goods that the seller is trying to eliminate from stock, perhaps to make way for new models.
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The Sales Discounts, Returns, Allowances contra revenue sales accounts may be presented on the income statement as individual line items or–if immaterial or preferable–aggregated into a single contra-revenue line. If the customer does not pay within the discount period and does not take the sales discount the business will receive the full invoice amount of 2,000 and the discount is ignored. If the customer pays within 10 days then a 2.5% sales discount amounting to 50 can be deducted from the sales invoice, and the customer will pay only 1,950 to settle the account.
Sales discount as a contra revenue account
The business receives cash of 1,950 and records a sales discount of 50 to clear the customers accounts receivable account of 2,000. A sales discount is a reduction taken by a customer from the invoiced price of goods or services, in exchange for early payment to the seller. The seller usually states the standard terms under which a sales discount may be taken in the header bar of its invoices. When a company offers sales discounts, it is essentially offering the customer a cash incentive to pay for their purchase earlier than when the account would normally be due. Sales returns and allowances is a deduction from sales that shows the sale price of goods returned by customers, as well as discounts taken by them to retain defective goods.
The sooner a company receives cash after providing a good or service, the better off it is financially. This is because the initial accounting journal entry at the time of sale was a debit to Accounts Receivable asset account and credit to a Sales Revenue account. The downside of scenario analysis explained offering a discount is that the business now has an extra cost. If we use the example above, the cost to the business of receiving 1, days earlier than expected was the sales discount of 50. When recording sales, trade discount is always deducted directly from the list price.
What is the accounting treatment for sales discounts?
A sales 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. Hence, a sales discount is not an expense but a contra-revenue account that offsets revenue. Therefore, the natural balance of a sales discount is opposite to the natural credit balance of a revenue account. As seen in the journal entry made above, the sales discount was recorded as a debit because it has a natural balance that is opposite to the natural credit balance of revenue. Expenses too are debits but in this case, the sales discount is recorded as a debit because it is a contra-revenue account and not an expense. Let’s look at some examples of how sales discount is treated not as an expense account but as a contra revenue account.
The sale account will report the value of an original sale while the contra-sale account will report the details of any sales discounts, returns, and allowance that reduces the value of the original sale. Trade discounts and sales discounts are the two main types of discounts in accounting that might occur in businesses. Trade discounts take place when the seller reduces the sales price for a wholesale customer, such as on bulk orders. A sales discount, on the other hand, occurs when a seller offers a sales price reduction to a customer as an incentive to pay an invoice within a certain time.
Suppose the XYZ company recorded only one invoice in their accounting period. Sales discounts allow companies to receive more money earlier at the expense of revenue which will be recognized in the future as time goes on. Isabella’s Educational Supply issues a $5,000 invoice to a customer and offers a 2% discount if the customer is able to pay the invoice amount within 10 days. The customer pays on the 5th day from the invoice date entitling him to the given discount of 2%. An expense is an operational cost that a business incurs in order to generate revenue.
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Sales Allowances contra revenue account records the value of reductions in selling price granted to buyers who agreed to accept a defective product instead of returning it to the seller. A contra revenue account is a revenue account that is expected to have a debit balance (instead of the usual credit balance). In other words, its expected balance is contrary to—or opposite of—the usual credit balance in a revenue account.
Sales discounts are also known as cash discounts or early payment discounts. Sales discounts (along with sales returns and allowances) are deducted from gross sales to arrive at the company’s net sales. Hence, the general ledger account Sales Discounts is a contra revenue account. A contra revenue account that reports the discounts allowed by the seller if the customer pays the amount owed within a specified time period.
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. As a contra revenue account, sales discount will have a debit balance and is subtracted from sales (along with sales returns and allowances) to arrive at net sales. When a sales discount is offered to few customers, or if few customers take the discount, then the amount of the discount actually taken is likely to be immaterial. In this case, the seller can simply record the sales discounts as they occur, with a credit to the accounts receivable account for the amount of the discount taken and a debit to the sales discount account. The sales discount account is a contra revenue account, which means that it reduces total revenues. If Music World returns merchandise worth $100 after receiving a $1,000 order, they still owe Music Suppliers, Inc., $900.
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