What is a Sales Discount?
Sales Discount is referred to as a discount that is extended to the customer in order to incentivize him to pay the amount early.
The slight deduction from the total bill depending on timely payment acts as a motivator for the debtors of the company, since they tend to try to utilize the discount, and pay back the amount in time.
In the normal course of business, companies might sell goods or services to their customers on credit. Regardless of the credit terms being mentioned in the contract, there are often circumstances where the buyers are not always able to pay back their debts in time.
In such cases, it is often challenging for the company (the seller of the goods) to manage their finances, because delayed payments might result in an altered cash flow for the company which is not always favorable for them in the long run.
Therefore, companies tend to offer sales discounts to their clients in order to give them an incentive to pay the amount before the agreed-upon date, so that their own liquidity and cash cycle stays uninterrupted, and the customer is also satisfied because he has availed a discount.
Therefore, sale discounts are very common, and companies across the world rely on these discounts to attract early payments from their buyers.
Accounting for sales discount
Since Sales Discounts decrease the total receivable amount from customers, they are categorized as a contra-revenue account.
This is because this particular amount is deducted from the Gross Sales in the Profit and Loss Account, in order to arrive at the Net Sales, as shown below:
|Less: Sales Discounts||5,000|
As far as Accounting for Sales Discounts is concerned, it can be explained using the categorization of sales discounts into trade discounts, and cash discounts. As far as Trade Discounts are concerned, they are the discounts given to customers to push sales.
They can be in the form of a certain percentage of the price of the product. Trade Discounts are not recorded as sales discounts, because they are the discounts that are offered, and agreed upon before the sale has actually been made.
On the other hand, cash discounts are discounts are discounts that are offered to attract customers for early settlement of their debts.
These are the discounts that are subtracted from the Gross Sales in order to determine the number of Net Sales that have been carried out by the company over the course of time.
Cash Sale Discounts are represented in the Sale Agreement as follows:
This particular format is interpreted as such that it means that the buyer of the goods is going to get a 10% discount if he pays within 15 days. Otherwise, the net amount is supposed to be paid in 30 days by the buyer.
Cash Discounts are represented in this manner, and they may, or may not include trade discounts. However, Cash Sales Discounts are represented in the format mentioned above.
Journal entries for sales discount
Journal Entries for Sales Discounts are posted in the following manner:
When a Sale is made on credit, the following journal entries are posted:
When the customer avails the cash discount offered, the following journal entry is posted:
Example and solution
In order to further explain how Sales Discounts work, the following example is given:
On 1st January, Feliz Inc., sold goods worth $1000 to Jayman Co. The agreed credit terms for the transaction were 10/15, net/30.
Jayman Co. settled the amount on 14th Jan.
Jayman Co. settled the amount on 20th Jan.
The credit terms that are put forth by Feliz Inc. mean that Jayman Co. is supposed to settle the amount due before 15th January, in order to avail a cash discount of 10%. Otherwise, the net amount would be payable in maximum 30 days (i.e. 30th January).
In the case where Jayman Co. settles the amount on 14th Jan, the cash discount is availed. So, the following journal entry is going to be made:
In the case where Jayman Co. settles the amount on 20th Jan, the cash discount is availed. So, the following journal entry is going to be made: