Companies attract customers through their products and services. 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.
What is a Sales Discount?
A sales discount is a reduction in the amount owed by a customer. This discount does not relate to a company’s operations, products, or services. Instead, they depend on the credit terms that companies offer. Sales discounts allow customers to pay a lower price for goods and services. However, this reduction is only valid if they pay promptly.
Another name used for sales discounts is cash discounts. These discounts allow companies to collect their receivables earlier. However, it depends on customers to utilize these discounts. 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.
How do Sales Discounts work?
When companies sell products or services, they may collect cash when the transaction occurs. However, some companies also offer credit terms, allowing customers to pay later. This strategy is crucial in allowing customers to purchase more products or services. However, companies may face an issue when collecting the owed amount. Usually, companies seek to receive these amounts as soon as possible.
It is where sales discounts can be helpful. 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. It allows companies to collect cash earlier, providing more investment opportunities. On the other hand, the customer pays a lower price for the goods.
What is the accounting treatment of Sales Discount?
As mentioned, companies usually offer two types of discounts. A trade discount is a reduction in the price of goods or services. Accounting standards do not require an accounting treatment for those discounts. However, sales discounts are different. With these, companies must record the sold items at the agreed price.
The recording of sales has the same journal entries as traditional sales. 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 journal entries for sales discounts.
| Dr | Discount allowed |
| Cr | Accounts receivable |
Example
A company, Red Co., sells goods worth $1,000 to a customer on credit. The company records these sales as follows.
| Dr | Accounts receivable | $1,000 |
| Cr | Sales | $1,000 |
Red Co. requires the customer to repay within 30 days. However, the company also offers a sales discount of 10% if the customer pays within the next ten days. The customer avails of the sale discount and reimburses Red Co. within eight days. Red Co. receives a total of $900 from the customer. Therefore, the company will record the sales discount with the following journal entries.
| Dr | Discount allowed | $100 |
| Dr | Cash | $900 |
| Cr | Accounts receivable | $1,000 |
Conclusion
A sales discount is a reduction of the money owed by a customer. 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. Sales discounts help with cash management and can reduce bad debts.
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