Discounts and their treatment in books of accounts


Discounts

When buying and selling goods it is normal for certain deductions to be made from the list price or the invoice price. These deductions are known as discounts. The two most common types of discounts are trade discounts and cash discounts.

Trade Discounts
A trade discount is also known as bulk discount or quantity discount.  This is a deduction from the list price of merchandise sold to large volume buyers or a certain category of customers.  For example, a pharmaceutical company may offer a trade discount to hospitals.  The percentage of trade discounts offered to different customers may vary.  For example, a manufacturing firm may offer a 30 percent trade discount to a wholesaler and a 20 percent trade discount to a retailer.  In both cases, the amount of the discount will be deducted from the total invoice price of the merchandise.

Trade discounts are not entered in accounting records. Only the net invoice amount is used in recording merchandise purchased or sold.

Example
On 10th May, 200X HOSCO sold 10 cartons of toilet paper to Ubungo Traders at a list price of shs. 6,000 per carton less 20 percent trade discount. The appropriate invoice will show the following amounts:


Qty
Particulars


Amount
10
Cartons @ shs. 6,000

60,000

less: 20 % trade discount
12,000

Net invoice


48,000

The net amount of shs. 48,000 will be used by HOSCO to record its sales, and by Ubungo Traders to record its purchase of 10 cartons of toilet paper.  The trade discount of shs. 12,000 will not be shown in the records of either HOSCO or Ubungo Traders.

Cash Discounts
Credit terms on the invoice may provide a cash discount if payment was made within a prescribed time period. For example, the credit terms may be expressed as "net 30 days", which means the net amount should be paid within 30 days from the invoice date.  This may be abbreviated in the invoice as "n/30".  If a cash discount of 2 percent is offered when the amount owing is paid within 10 days, then the invoice will show the credit terms as "2/10, n/30".  This means 2 percent cash discount is deductible if payment is made within 10 days or the net amount is payable within 30 days.  Some invoices demand settlement by the end of the month of sale. This will be abbreviated as “n/EOM” which means the amount due is payable by the end of the month.

Cash discounts are recorded in a separate account in the accounting books of the seller and the buyer. If HOSCO offered a 2 percent cash discount if the amount owing was paid within 10 days and that Ubungo Traders took advantage of the discount, the amounts of cash discount and cash payable are calculated as follows:


Particulars


Amount
Net invoice value

48,000
Less: cash discount 20% of shs. 48,000
960
Cash due
47,040

Note that the cash discount was calculated on the net invoice price (after trade discount was deducted).
Recording Cash Discounts
(a)        Sales Discount or Discount Allowed

            From the seller’s perspective, the cash discount which HOSCO will grant Ubungo Traders is termed Sales Discount or Discount Allowed.  It will be recorded in the Cash Receipts Journal where a special column will be designated for this account. Since the seller receives less than what he would have received had he waited the full credit period, discount allowed is treated as an expense item.

(b)        Purchase Discount or Discount Received

            From the buyer’s perspective, the cash discount, which Ubungo Traders will receive from HOSCO, is termed Purchase Discount or Discount Received.  It will be recorded in the Cash Payments Journal where a special column will be designated for this account. Since in this case the customer is paying less than what he would have paid had he waited the full credit period, discount received is treated as a revenue item.

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