Types of Discounts
In accounting, there are two primary types of discounts:
Key Facts
- Types of Discounts: There are two primary types of discounts in accounting – trade discounts and cash discounts. Trade discounts are offered to wholesale customers and do not appear in accounting records or financial statements specifically. Cash discounts, also known as sales discounts, are offered to customers as an incentive to pay an invoice within a certain time.
- Recording Discounts: Sales discounts should not be recorded as an expense in your books. Instead, they should be treated as reduced sales – by value. This means that the discount amount should be deducted from the total sales revenue to reflect the actual revenue earned after accounting for discounts.
- Journal Entries: To properly record a cash discount, you need to follow specific journal entries. Here is an example using a 1% discount on a $100 invoice:
- Debit the accounts receivable account by the full invoice amount ($100).
- Credit the sales revenue account by the same amount ($100).
- Debit the cash account by the amount received after the discount ($99).
- Debit the sales discounts account by the discount amount ($1).
- Credit the accounts receivable account by the full invoice amount ($100).
- Reporting the Discount: The amount of total sales discounts for an accounting period should be reported on the income statement under a line called “Less: Sales Discounts”. This amount is subtracted from the gross sales revenue to calculate the net sales figure.
- Trade discountsOffered to wholesale customers and do not appear in accounting records or financial statements specifically.
- Cash discounts (sales discounts)Offered to customers as an incentive to pay an invoice within a certain time.
Recording Sales Discounts
Sales discounts should not be recorded as an expense in accounting books. Instead, they should be treated as reduced sales by value. This means that the discount amount should be deducted from the total sales revenue to reflect the actual revenue earned after accounting for discounts.
Journal Entries for Sales Discounts
To record a cash discount, the following journal entries are used:
- Debit the accounts receivable account by the full invoice amount.
- Credit the sales revenue account by the same amount.
- Debit the cash account by the amount received after the discount.
- Debit the sales discounts account by the discount amount.
- Credit the accounts receivable account by the full invoice amount.
Example
Consider an invoice of $100 with a 1% discount. The journal entries would be:
- Debit Accounts Receivable: $100
- Credit Sales Revenue: $100
- Debit Cash: $99
- Debit Sales Discounts: $1
- Credit Accounts Receivable: $100
Reporting Sales Discounts
The total sales discounts for an accounting period are reported on the income statement under a line called “Less: Sales Discounts.” This amount is subtracted from the gross sales revenue to calculate the net sales figure.
Sources
- “How to Treat Customer Discounts in Your Bookkeeping” (Fleximize, https://fleximize.com/articles/001659/how-to-treat-customer-discounts-in-your-bookkeeping)
- “How to Handle Discounts in Accounting” (Chron, https://smallbusiness.chron.com/handle-discounts-accounting-50638.html)
- “Sales Discounts” (Finance Strategists, https://www.financestrategists.com/tax/sales-discounts/)
FAQs
What is a sales discount?
**Answer:** A sales discount is an incentive offered to customers to encourage prompt payment of invoices.
How are sales discounts recorded in accounting?
**Answer:** Sales discounts are not recorded as expenses, but rather as a reduction in sales revenue.
What is the journal entry to record a sales discount?
**Answer:** Debit the accounts receivable account, credit the sales revenue account, debit the cash account, debit the sales discounts account, and credit the accounts receivable account.
How are sales discounts reported on the income statement?
**Answer:** The total sales discounts for a period are reported on the income statement under a line called “Less: Sales Discounts.”
What is the difference between a trade discount and a sales discount?
**Answer:** A trade discount is offered to wholesale customers and does not appear in accounting records, while a sales discount is offered to customers as an incentive to pay early.
Why is it important to record sales discounts correctly?
**Answer:** Correctly recording sales discounts ensures accurate financial reporting and prevents overstatement of revenue.
What are the benefits of offering sales discounts?
**Answer:** Sales discounts can improve cash flow, strengthen customer relationships, and increase sales volume.
What are the potential drawbacks of offering sales discounts?
**Answer:** Sales discounts can reduce profit margins and lead to customers expecting discounts on future purchases.