Overview of Discounts Allowed
A company may offer clients a discount if they pay their bills on time in business. When clients take advantage of the discount by making an early payment, the company must account for it with an appropriate journal entry.
Because the company records the total amount as sales income when a credit transaction is made, the sales revenue must be reduced when the consumer accepts the discount.
On the other hand, the corporation does not normally debit the sales revenue account directly. To maintain track of the discounts taken by customers, it usually registers such a discount in the discount allowed account.
When is Discount Allowed Given?
Discounts are allowed when the customer is buying more than one item.
The seller may offer a discount if the customer purchases more than one item in some cases. This is called quantity discount or multi-unit discount. However, this will depend on how much the seller can sell in a certain amount of time or how many items are left in stock.
For example, if a person buys two items instead of one at a total price, they may receive a 10% discount on both items. If a person buys three items instead of one at a total cost, they may receive a 20% discount on all three items.
An example of this would be if you bought two books and received 10% off each book or three books and received 20% off each book (“2+1”).
Another example would be if you bought four shirts and received 10% off each shirt or five shirts and received 15% off each shirt (“3+1”).
How to Record Discounts Allowed in Journal Entry?
The discount Allowed account is used to record discounts allowed on sales. The discount allowed amount is posted to the Sales Discounts account and then the Cost of Goods Sold. The following journal entries are made:
To record discount allowed on sales:
1. Record the sale as usual in the Sales Journal.
2. Post the sale to cost of goods sold by debiting Cost of Goods Sold and crediting Sales Revenue.
3. Post the discount allowed by debiting Sales Discounts and crediting Allowance for Doubtful Accounts (if any).
4. Post the difference between the net sales price and the gross amount of sales by debiting the discount Allowed and crediting Sales Revenue less Cost of Goods Sold less Allowance for Doubtful Accounts (if any).
Discount Allowed Journal Entry Examples
For example, XYZ Ltd. company gets payment for a product it sold on credit for $3,000 the week before. Because the customer took advantage of the company XYZ Ltd.’s early payment discount of 3% by paying during the discount period, the total cash payment received is only $2,910.
In this scenario, XYZ can enter the following journal entry for the discount allowed with the cash received:
The net balance of sales is lowered by $90 in this journal entry because the consumer took advantage of XYZ Ltd.’s early payment incentive.
Mr. Adam is selling a $10,000 dispenser. If a consumer buys two dispensers from Mr. Adam, he gets a 5% trade discount. A further 2.5% discount is granted on the total sales value if the consumer pays in cash upfront.
The seller offers two types of discounts in this case: a 5% trade discount to boost sales and a 2.5% cash discount as an incentive to pay quickly.
The trade discount is not recorded in the books, and sales are reported net of the given trade discount.
Recording Sales Transaction (two dispensers):
Thai Corporation has offered to sell their bicycles at a 12% discount off their quoted price of $150 as part of a sales promotion effort. Customers receive a $10 cash discount if they pay within five days of the purchase date. Mr. Louis buys a bicycle from Thai Corporation and pays within five days.
Before we get started on the accounting entries, it’s essential to understand the two sorts of discounts that Thai corporations offer. Because the 12% reduction is a trade discount, it should not be recorded in Thai Corporation’s accounting records. The $10 discount is a cash discount, and it must be handled as such.
The following is how the bicycle’s first sale will be recorded:
Because Mr. Louis is eligible for a cash discount, the following duplicate input is necessary to record the discount:
As a result of the entries described above, Thai Corporation’s sales have been lowered to $122 per unit (150-18-10). Mr. Louis’s receivable has likewise been effectively decreased to this amount.
Effect of Discounts Allowed on Financial Statements
Discounts allowed on financial statements are the difference between the cost of an asset and its book value. The discounts allowed on financial statements are an expense that reduces net income for the period.
The discount may be due to a bargain purchase, which is a purchase at a price below the fair market value of an asset, or it may be due to a write-down of inventory that has declined in value.
The discount allowed on financial statements is recorded as a contra asset account called “Discounts Allowed.” The effect of discounts allowed on financial statements depends on whether they are written off or not.
If they are not written off, they reduce net income by their total amount for the period. If they are written off, their effect is similar but more complicated. Any write-off must be done over several periods, with adjustments made each period to reflect changes in their size between periods.