This means that the sales discount that was issued during the accounting period cost the business $500. However, in accounting a sales discount is not treated as an expense account but as a contra-revenue account. Hence, we will discuss sales discount, expense, and why sales discount is not an expense. Most businesses do not offer early payment discounts, so there is no need to create an allowance for sales discounts. However, a company may decide to just simply record its net sales in its income statement, rather than reporting the sales discount and gross sales separately. This is normally common when the amount of sales discount is so small that a separate line item presentation does not yield any material additional information for the reader of the financial statement.
- 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.
- In order to encourage early payment, each business normally provides a sales discounts if customers make payment within the discount period.
- Trade discounts take place when the seller reduces the sales price for a wholesale customer, such as on bulk orders.
This means that a sales discount is not an expense but a contra-sales account. 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. Sales discounts will entice customers to pay ahead of time their credit purchases which in turn will improve the collection of a company’s accounts receivable.
Examples of sales discount as a contra revenue account and not an expense
To illustrate a sales discount let’s assume that a manufacturer sells $900 of products and its credit terms are 1/10, n/30. This means that the buyer can satisfy the $900 obligation if it pays $891 ($900 minus $9 of sales discount) within 10 days. Thus, companies should ascertain whether or not offering sales discounts will truly benefit them in the long run.
- Some companies created an allowance account to record the sales discount when the potential cash discount would happen in the next accounting period.
- 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.
- 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.
- To record this payment to Music Suppliers, Inc., Music World makes a compound journal entry that decreases (debits) accounts payable for $900, decreases (credits) cash for $882, and increases (credits) purchases discounts for $18.
- This is more informative for the reader of the financial statements rather than when only the company’s net balance is reported on the income statement.
However, as customers take advantage of the sales discount, the overall revenue figures for the business tend to reduce. This sacrifice is, nonetheless, done by businesses in order to encourage early payments and reduce bad debt. In addition, early payments support the liquidity position of the company and reduce the company’s outstanding accounts receivable.
Let’s say Company ABC offered the customer a sales discount term of ‘2/10 net 30’. In order to encourage early payment, each business normally provides a sales discounts if customers make payment within the discount period. 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. It effectively costs the business 46.72% to offer sales discounts to the customer. Due to its high cost, it can be seen that sales discounts should be offered sparingly.
Effects of Sales Discounts on Businesses
ABC Ltd sold merchandise to Company RST for a total sales price of $100,000. Say, Company RST is given 30 days to pay the amount and will be granted a 5% discount if it pays within 10 days. By doing so, you can immediately reduce sales by the amount of estimated discounts taken, thereby complying with the matching principle. In contrast, in the multiple-step income statement, sales discounts presented separately as a reduction in sales. 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.
The full amount owed by the customer is shown as a balance sheet asset (accounts receivable) and included as revenue in the income statement. This transaction is more fully explained in our sales on account example. This entry will recognize the sale amount $25k as well as recognizing the account receivable amount $25K in the income statement. The recognition of the sales is at gross before cash discount since the customer does not make the payment yet.
Trial Balance
If the customer pays within the 10 days and takes the sales discount of 50, then the business will only receive cash of 1,950 and accounts for the difference with the following sales discounts journal entry. As seen in the income statement report above, the sales discount as a contra revenue account appears as a $1,500 reduction from the gross revenue of $30,000 that Jenny’s organics recorded. As seen in the income statement above, the sales discount is a contra-revenue account and not an expense.
What is a Sales Discount?
Now, that we have an understanding of sales discount, is sales discount an expense? 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.
In these examples, we will see how sales discount as a contra revenue account is recorded as a debit which is contrary to the natural credit balance of revenue. Assume, Company ABC sold $100 worth of goods to a customer who will pay the invoice at a later date. Company https://accounting-services.net/are-sales-discounts-reported-as-an-expense/ ABC will record this transaction as a debit of $100 to accounts receivable and a credit of $100 will be made to the sales revenue account. Therefore, companies that offer small discounts for a 10-day payment return are able to clear their accounts quickly.
Terms Similar to Sales Discount
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. An example of a sales discount is 2/10 net 30 terms, where a customer can take a two percent discount if it pays an invoice within ten days of the invoice date, or pays full price 30 days after the invoice date. The sales discount concept can also be applied to cash sales, where a discount is offered in exchange for immediate payment.
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. It is a reduction in credit sales if customers make the payment within the discount period. In this term, if customers make payment within 10 days, they receive a cash discount of 2% and the credit period is 30 days. While it is acceptable to record and report discounts, returns and allowances within the sales revenue account–especially for very small businesses–doing so leads to the loss of valuable information and insights. 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.