A sales discount is a reduction in the price of a product or service that is offered by the seller, in exchange for early payment by the buyer. A sales discount may be offered when the seller is short of cash, or if it wants to reduce the recorded amount of its receivables outstanding for other reasons.
An example of a sales discount is for the buyer to take a 1% discount in exchange for paying within 10 days of the invoice date, rather than the normal 30 days (also noted on an invoice as “1% 10/ Net 30” terms). 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.
If a customer takes advantage of these terms and pays less than the full amount of an invoice, the seller records the discount as a debit to the sales discounts account and a credit to the accounts receivable account. The sales discounts account appears in the income statement and is a contra revenue account, which means that it offsets gross sales, resulting in a smaller net sales figure.
|Less: sales discounts||(xxx,xxx)|
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.
If the number of discounts taken by customers are few and the impact of these discounts on reported sales results are minimal, then the accounting treatment just noted is acceptable. However, what if many discounts are taken? You could have a situation where a company issues most of its invoices at the end of a month (a common scenario) and then customers take discounts in the following month, which reduces sales in a different period from the one in which the invoices were originally generated. This scenario does not pass standard set by the matching principle, where all revenues and expenses associated with a transaction should be recognized within the same period.
If there is a risk that a large proportion of sales discounts will be recognized in a later period, create a sales discounts allowance account, in which you record an estimate of what the sales discounts will actually be in a later period. By doing so, you can immediately reduce sales by the amount of estimated discounts taken, thereby complying with the matching principle.
Product catalogs often provide a list price for an item. Those list prices may bear little relation to the actual selling price. A merchant may offer customers a trade discount that involves a reduction from list price. Ultimately, the purchaser is responsible for the invoice price, that is, the list price less the applicable trade discount. Trade discounts are not entered in the accounting records. They are not considered to be a part of the sale because the exchange agreement was based on the reduced price.
Remember the general rule that sales are recorded when an exchange takes place. The measurement of the sale is based on the exchange price. Therefore, the amount recorded as a sale is the invoice price. The entries previously shown for a $4,000 sale would also be appropriate if the list price was $5,000, subject to a 20% trade discount.
Credit Card PictureIn the retail trade, merchants often issue credit cards. Why? Because they induce people to spend, and interest charges that may be assessed can themselves provide a generous source of additional profit. However, these company issued cards introduce lots of added costs: customers that don’t pay (known as bad debts), maintenance of a credit department, periodic billings, and so forth.
To avoid these issues, many merchants accept other forms of credit cards like Visa and MasterCard. When a merchant accepts these cards, they are usually paid instantly by the credit card company (net of a service charge that is negotiated in the general range of 1% to 3% of the sale). The subsequent billing and collection is handled by the credit card company. Many merchants will record the full amount of the sale as revenue, and then recognize an offsetting expense for the amount charged by the credit card companies.
Merchants often sell to other businesses. Assume that Barber Shop Supply Company sells equipment and supplies to various barber shops on open account. An open account is a standing agreement to extend credit for purchases. In these settings, the seller would like to be paid promptly after billing and may encourage prompt payment by offering a cash discount (also known as a sales discount).
There is a catch, though. To be entitled to the cash discount, the buyer must pay the invoice promptly. The amount of time one has available to pay is expressed in a unique manner, such as 2/10, n/30. These terms mean that a 2% discount is available if the purchaser pays the invoice within 10 days; otherwise, the net amount is expected to be paid within 30 days.