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Cash Discount

Definition

Cash discount is a reduction in the amount due from a customer as an incentive for immediate or early payment.

Contents
  1. Definition of cash discount
  2. Accounting treatment
  3. Examples

Accounting for Cash Discounts

Unlike trade discounts which are not reflected in the accounting system, cash discounts are recorded as "Sales Discount" in the books of the seller and "Purchase Discount" in the books of the buyer under the periodic inventory method. Under the perpetual inventory method, the buyer records it as a reduction (credit) in its inventory account.

Cash discounts may be recorded in the books of the company using the gross method or the net method. The gross method is more popular among the two. Under the gross method, sales and purchases are initially recorded at gross amount and when the discount is taken, "Sales Discount" (seller) or "Purchase Discount" (buyer) is recorded.

Under the net method, sales and purchases are recorded at net of cash discount. When the discount is not taken, "Sales Discount Forfeited" (seller) or "Purchase Discount Lost" (buyer) is recognized.

Example - Records of the Seller

Company S sold merchandise to Company B for $2,000. A 5% discount will be given if Company B pays the amount within 10 days. In the books of Company S, the journal entries would be:

Gross Method:

1. To record the sale of goods

Dr. Accounts Receivable 2,000.00  
Cr. Sales   2,000.00

2. To record collection of account, assuming the buyer paid within 10 days

Dr. Cash 1,900.00  
Dr. Sales Discount 100.00  
Cr. Accounts Receivable   2,000.00

3. Assuming the buyer paid after the lapse of the discount period

Dr. Cash 2,000.00  
Cr. Accounts Receivable   2,000.00

Net Method:

1. To record the sale of goods

Dr. Accounts Receivable 1,900.00  
Cr. Sales   1,900.00

2. To record collection of account, assuming the buyer paid within 10 days

Dr. Cash 1,900.00  
Cr. Accounts Receivable   1,900.00

3. Assuming the buyer paid after the lapse of the discount period

Dr. Cash 2,000.00  
Cr. Accounts Receivable   1,900.00
Cr. Sales Discount Forfeited   100.00

If the net method is used, "Sales Discount Forfeited" is treated as other income.

Example - Records of the Buyer

Using the same information ($2,000, 5% cash discount if paid within 10 days) and assuming the periodic inventory method is used, the journal entries in the books of the Company B would be:

Gross Method:

1. To record the purchase of goods

Dr. Purchases 2,000.00  
Cr. Accounts Payable   2,000.00

2. To record payment of the account, assuming the buyer paid within 10 days

Dr. Accounts Payable 2,000.00  
Cr. Cash   1,900.00
Cr. Purchase Discount   100.00

3. Assuming Company B paid after the lapse of the discount period

Dr. Accounts Payable 2,000.00  
Cr. Cash   2,000.00

Net Method:

1. To record the purchase of goods

Dr. Purchases 1,900.00  
Cr. Accounts Payable   1,900.00

2. To record payment of the account, assuming the buyer paid within 10 days

Dr. Accounts Payable 1,900.00  
Cr. Cash   1,900.00

3. Assuming Company B paid after the lapse of the discount period

Dr. Accounts Payable 1,900.00  
Dr. Purchase Discount Lost 100.00  
Cr. Cash   2,000.00

If the net method is used, "Purchase Discount Lost" is treated as other expenses and losses.

If the buyer uses the perpetual inventory method, there would be no "Purchases", "Purchase Discount", and "Purchase Discount Lost" accounts. Instead, they are all recorded in the inventory account such as "Merchandise Inventory" or simply "Inventory".

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