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 recording in the income statement. In other words, the value of sales recorded in the income statement is the net of any sales discount – cash or trade discount.

Table of contents

• What is Accounting for Sales Discounts?
  • Explanation
  • Examples
  • Accounting for Sales Discounts on Income Statement
  • Journal Entries of Accounting for Sales Discounts
  • Advantages
  • Disadvantages
  • Recommended Articles

  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 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 sales discount is calculated as a particular percentage of the sales price and can be in the form of cash or trade discount 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., which 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 ten 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:

  

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

  

  Example #2

  Let us take the example of DFG Inc., which 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 a 5% discount expiry.
  2. SWE Inc. makes the payment on April 07, 2019, and avails of an additional 5% discount.

  In both cases, the customer enjoys an introductory 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:

  

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

  

  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. On the income statement, it is reported as a separate line item as “net sales” on the income statement. The net sales refer to the actual amount of revenue earned during the period. In the income statement, it is recorded, as shown below:

  

  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.

  As a result of the above transaction, the outstanding amount of accounts receivable accounts 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.

  As a result of the above transaction, the outstanding amount of accounts receivable is reduced by increasing the aggregate value of cash and sales discount.

  Advantages

  • The customers can buy the goods at slightly 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, the buyer will effectively lose money on the transaction.

  Recommended Articles

  This has been a guide to what is Accounting for Sales Discounts. Here we discuss examples, income statements, and journal entries along with advantages and disadvantages. You may learn more about financing from the following articles –

  • Cash Discount
  • Difference Between Trade Discount and Cash Discount
  • Volume Discount
  • Invoice Discounting