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.
This is one of the best ways most of the sellers could improve the cash flow for their operations.
The amount of sales discount is deducted from the gross sales to calculate the company’s net sales and recorded in a separate sales discount account.
The sales discount account is reported on the income statement as a contra revenue account which means that it is directly deducted from the gross sales and does not appear in the expense section.
It is also not shown in the face of financial statements as well as in the noted to sales or revenue of financial reports.
Sales discount in income statement may be presented as:
Value of Gross Sales xxx
Less: Value of Sales Discounts (xxx)
Net Sales xxx
Less: Expenses(xxx)
Profit / Loss xxx
Types of Sales Discounts:
In normal business generally, there are two types of discounts. Trade discounts and sales discounts or cash discounts.
Trade discount refers to the reduction in the price of a commodity or service sold to wholesalers at the time of bulk purchases.
Trade discounts are not recorded as sales discounts and deduct directly at the time recording sales.
Sales or Cash Discounts are properly recorded and shown in the financial statements. The common terms used for sales discounts are 10%, 2/15, n/30.
Let’s discuss the step by the step accounting treatment of sales discount.
Initial Recognition of Sales Transaction:
The best practice to record a sales entry is debiting the accounts receivable with full invoice and credit the revenue account with the same amount.
For example, XYZ a cement distributor firm issues an invoice worth $25,000 to a customer allowing 3% discount on invoice price if the customer pays within the 10 days. The XYZ should initially recognize the transaction in the following way:
Dr – Accounts Receivable $25,000
Cr – Sales Revenue $25,000
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.
The discount is applicable only if the customer making the payment and the payments are within the term and condition which is within the 10 days.
Subsequent entry:
In case the customer is making the payment for the goods that they purchase based on the term and condition and the company is using or maintaining the Sales discount account, then here is the entry to records the sales discount as well as the payments from the customer.
Dr – Cash/Bank $24,250
Dr – Sales Discount $750
Cr – Accounts Receivable $25,000
As you can see in this entry, $750 is the sales discount or cash discount which is recorded as expenses and the company received cash only $24,250.
The total account receivable of $25,000 is discharged from the account receivable balance during the time the customer makes payment.
In case the company uses or maintain the allowance for sales discount account, then the records will as the following:
Dr – Cash/Bank $24,250
Dr – Allowance for Sales Discounts $750
Cr – Accounts Receivable $25,000
Both cash or sales discount and allowance for sales discount is the same.
They are the expenses account which is reported in the income statement for the period that the allowance or discount occurs.
The above example is for the case that the customer makes the payment within 10 days and the discount is allowed.
What if the payment is after 10 days?
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.
Right?
Here is the entry in case sales discount is not applicable and customer making the payment for all of the invoices:
Dr – Cash/bank $25,000
Cr – Account receivables $25,000
As you can see, full amounts of cash are received and the full amount of account receivables are discharged from the company account.
Here is how the sales or cash discount is calculated.
Calculation of discount amount* = Gross * Discount Percentage
= $25,000*3%
= $750*.
The above are the entries and the calculation of the sales discount.
But, how do we present it in the income statement?
The sales discount will be shown in the company’s profit and loss statement for an accounting period below as the gross revenue of the company.
Suppose the XYZ company recorded only one invoice in their accounting period.
The other only expense for the period is office rent worth $5,000. The income statement of the XYZ Company will show the following figures.
Gross Sales $25,000
Sales Discount ($750)
Net Sales$24,250
Expenses:
Office Rent$5,000
Net Profit / Loss for the Period$19,250.
