Cash Discount on Sales

Cash discount is the discount offered by seller for paying cash early. Cash discount is only offered on credit sales where the customers do not pay at the time of sale but promise to pay latter. There are two methods of accounting for sales that offer cash discounts; the gross method and the net method. These two methods are explained with the help of the following example:

Example

Suppose Company A sells certain goods at a price of $4,400 with terms of payment of 2/10 n/20. These terms of payment mean two things. Firstly, the customer must pay within 20 days after sale or, in other words, they have right to postpone the payment up to the 20th day after sale. Secondly, if the payment is made within 10 days, the customer will also be entitled to a 2% cash discount. Since most customers would try to benefit from the cash discount, such a practice encourages customers to pay early.

Now let us try to journalize the sale which offers a cash discount.

Since at the time of sale it is not possible to know whether the customer will actually avail the discount, therefore Company A would choose either gross method or net method. Once it chooses one method it would have to record all sales according to that method.

Gross Method

According to gross method the company would initially record the sale at gross or full price of $4,400. The journal entry would be:

Accounts Receivable4,400
Sales4,400

Subsequently, if the customer pays within 10 days, he would be entitled to avail the cash discount. The journal entry to record payment would be:

Cash4,312
Sales Discounts88
Accounts Receivable4,400

However, if the customer does not pay within 10 days, they would not be entitled to avail the cash discount and the journal entry to record the payment would be simple:

Cash4,400
Accounts Receivable4,400

Net Method

According to the net method the company would initially record the sale at net price.

Net Price = Gross Price − Potential Cash Discount

Net Price = $4,400 − 88 = $4,312

Accounts Receivable4,312
Sales4,312

For payment within 10 days:

Cash4,312
Accounts Receivable4,312

For payment after 10 days:

Cash4,400
Accounts Receivable4,312
Sales Discounts Forfeited88

Written by Irfanullah Jan