Sales Discount: Accounting, Journal Entry, Example, Debit or Credit

It is a reduction of gross sales which correspondingly causes a decrease in the net sales figure. As seen in the financial report above, the sales discount as a contra revenue account appears as a $9 reduction from the gross revenue of $900 that the manufacturer reported, which results in net revenue of $891. Let’s look at some examples of sales discount as a contra revenue account and how it is recorded as a debit contrary to the natural credit balance of revenue. Cash discounts result in the reduction of sales revenue earned during the period.

Revenue or Sales reported on the income statement are net sales after deducting Sales Returns and Allowances and Sales Discounts. Users may want to add a discount amount on the sales invoice line level and have the discount amount post to a specific GL account. It is included in the cash discount which is shown on the challan/invoice. As per prevailing practice or terms of purchase and sale, a certain amount of money determined at a fixed rate and deducted from invoice price or amount receivable is called the discount.

• Sales Allowances contra revenue account records the value of reductions in selling price granted to buyers who agreed to accept a defective product instead of returning it to the seller.
• 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.
• Sales discounts help with cash management and can reduce bad debts.
• By doing so, you can immediately reduce sales by the amount of estimated discounts taken, thereby complying with the matching principle.
• The total sales discounts are then subtracted from the gross sales revenue that has been earned in the period before accounting for discounts.
• Sales discounts allow companies to receive more money earlier at the expense of revenue which will be recognized in the future as time goes on.

This improves cash flow and reduces the risk of bad debt and invoice aging. Hence, companies offering small discounts for a 10-day payment return help to clear accounts quickly. Customers taking advantage of the sales discount tend to reduce the overall revenue figures for the business but encourage early payments as well as reduce bad debt. Moreso, early payments support the liquidity position of the company and reduce outstanding accounts receivable.

Debit or Credit?

Sales discounts help with cash management and can reduce bad debts. These discounts allow companies to collect their receivables earlier. Sales discounts usually fix a date or time for customers to repay. If they fail to reimburse the company until then, they will not receive the reduction in payment. Sales discounts are also crucial for cash and liquidity management. A company offers its business customer sales discounts of 1/10, net 30.

It is therefore necessary to record the initial sale at the gross amount (after deducting any trade discounts!) and subsequently decreasing the sale revenue by the amount of discount that is actually allowed. This discount applies to products and services after the sales occur. Usually, it involves allowing customers to repay the company at an earlier date. Companies must record this discount as an expense in the accounts.

Say, Company ABC 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. A company may choose to simply present its net sales in its income statement, rather than breaking out the gross sales and sales discounts separately.

In addition to those, companies also provide other packages or incentives. These incentives come through the provision of credit terms and incentives. On top of these, companies also offer discounts that promote more sales. Usually, companies provide two forms of discounts, namely sales and trade discounts.

Differences between Trade Discount and Cash Discount

A sales discount is a reduction in the price of a product or service that is offered by the seller, in exchange for early payment by the buyer. 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. When a contra asset account is first recorded in a journal entry, the offset is to an expense. For example, an increase in the form of a credit to allowance for doubtful accounts is also recorded as a debit to increase bad debt expense. Debiting discount allowed ledger has the effect of reducing gross sales revenue by the amount of cash discount allowed. Consequently, receivables are credited to reduce their balance to the amount that is expected to be recovered from them, i.e. net of cash discount.

Contra liabilities reduce liability accounts and carry a debit balance. Contra equity accounts carry a debit balance reduce equity accounts. Contra revenue accounts reduce revenue accounts and have a debit balance. There are two primary types of discounts in accounting that might occur in your small business – trade discounts and cash discounts. A trade discount occurs when you reduce your sales price for a wholesale customer, such as on a bulk order.

Contra Account Definition, Types, and Example

Now, if Mr John makes full payment before 15th Sept 2020, a 5% discount will be given. Thus, the net effect of the allowance technique is to recognize the estimated amount of the discount at once and park that amount in an allowance account on the balance sheet. Then, when the customer actually takes the discount, you charge it against the allowance, thereby avoiding any further impact on the income statement in the later reporting period.

It can also be an incentive for customers to pay faster, or support repeat business. Credit the accounts receivable account in the same journal entry by the full invoice amount. “Sales Discount” is a contra-revenue account; presented as a deduction from “Sales” in the income statement to come up with the “Net Sales”. The computation can also be presented in the notes to financial statements.

What is a Sales Discount?

A debit of $100 will be made to accounts receivable and a credit of $100 will be made to the sales revenue account. Sales discounts are not only beneficial to the company, but it also benefits the buyer too. When a customer takes advantage of an early payment discount, the amount that was supposed to be paid is reduced by a certain percentage. The disadvantage of this, however, to the seller is that they bear the brunt of lower revenue due to sales discounts.

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What Are the Different Types of Contra Accounts?

The total account receivable of $25,000 is discharged from the account receivable balance during the time the customer makes payment. Let’s discuss the step by the step accounting treatment of sales discount. Trade discount refers to the reduction in the price of a commodity or service sold to wholesalers at the time of bulk purchases. Sales discounts allow companies to receive more money earlier at the expense of revenue which will be recognized in the future as time goes on. Contra accounts provide more detail to accounting figures and improve transparency in financial reporting.

Using the previous example, assume you had $20,000 in gross revenue during the period. Nonetheless, it is usually advisable to use a revenue account and a contra-revenue account when recording sales. The revenue account reports the value of an original sale while the contra revenue account reports the details of any discounts, returns and allowance that reduces the value of the original sale. A contra-revenue account allows the company to see the original amount sold and also see the items that reduced the sales to the net sales amount.

The 10% discount is a trade discount and should therefore not appear in Bike LTD’s accounting records. The $5 discount is a cash discount and must be dealt with accordingly. The recording of sales has the same journal entries as traditional sales.

This is reported as ‘Net sales $19,700’ below the sales discounts line. Offering a sales discount incentivizes the buyers or customers to pay invoices in a timely manner. When a company’s invoices are settled early, it helps reduces the amount of time that the business is extending credit.

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The sales discounts account is presented on the income statement as a contra-revenue account, that offsets gross sales, which results in a smaller net sales figure. Subtract the total sales discounts from the gross sales revenue you earned in the period before accounting for discounts. Report your result as “Net sales” below the sales discounts line on your income statement. The amount of net sales is the actual revenue you earned after accounting for discounts.

However, the accounting for sales discount applies when customers avail the reduction in the owed amount. In that case, the company must record an expense for the reduced amount. Usually, companies use the following the definition and formula of social security tax journal entries for sales discounts. With these discounts, companies offer customers the chance to reduce the owed amount. However, they also set an expiry time for it, which is before the credit term expires.