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The above example is for the case that the customer makes the payment within 10 days and the discount is allowed. So if the customer is making the payment after 10 days, the discount is not applicable to them. Then the payment needs to be made in full. Here is the entry in case sales discount is not applicable and customer making the payment for all of the invoices:.
As you can see, full amounts of cash are received and the full amount of account receivables are discharged from the company account. The income statement of the XYZ Company will show the following figures. Overview: 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. Related article Operating leases on Balance Sheet Explained. Search for:. What are the types of Preference Shares?
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. Trade discounts are generally ignored for accounting purposes in that they are omitted from accounting records. Therefore, sales, along with any receivables in the case of a credit sale, are recorded net of any trade discounts offered.
Cash discounts result in the reduction of sales revenue earned during the period. However, not all customers may qualify for the cash discount. It is therefore necessary to record the initial sale at the gross amount after deducting any trade discounts! Debiting discount allowed ledger has the effect of reducing gross sales revenue by the amount of cash discount allowed.
Consequently, receivables are credited to reduce their balance to the amount that is expected to be recovered from them, i. Before we proceed with the accounting entries, it is necessary to first distinguish between the two types of discounts being offered by Bike LTD. As XYZ qualifies for the cash discount, the following double entry will be required to record the discount allowed:. The sales discount normal balance is a debit, a cost to the business.
The discount is recorded in a contra revenue account which is offset against the revenue account in the income statement. 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, and the discount is ignored. In this instance the accounts receivable is cleared by the receipt of cash and no sales discount is recorded.
The purpose of a business offering sales discounts is to encourage the customer to settle their account earlier 10 days instead of 30 days in the above example. By receiving payment earlier the business now has use of the cash for an extra 20 days and reduces the chances that the customer will eventually default.
The downside of 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, 20 days earlier than expected was the sales discount of This is the rate for the use of the funds for 20 days, to convert this to an annual percentage rate APR we simply divide by 20 to convert it to a daily rate, and then multiply by It effectively costs the business Due to its high cost, it can be seen that sales discounts should be offered sparingly.
From the customers point of view, the benefit of paying early is that they get cheaper prices for the goods they purchase.
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