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Sales Discounts

Lesson
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They say that cash flow is king when running a business.

Having cash in one's hand eliminates the risk of non-payment or late payment.

Having cash in one's hand also allows one to pay off his own debts sooner and to enter into negotiations with a greater degree of bargaining strength.

Because cash is so important, many businesses will offer discounts to customers who pay early.

For instance, a company may bill a customer $500, but then promise to knock off 3% if payment is received within 5 days.

This is all well and good, but how should this practice be noted in a vendor's financials?

There are two accepted methods:

  • Gross Method - Record the sale as if no discount will be taken
  • Net Method - Record the sale as if a discount will be taken

The vendor will deal with a customer payment differently, depending upon which method has been chosen and whether the customer pays his bill early.

Question
Ginny LLC, the little-known mug exporter, made a $824.00 sale under the following terms: 5/5, net 30 (5% discount if paid within 5 days, all payments due within 30 days).
Assuming that the customer does not pay early, what are the journal entries required for the sale and payment under the net method?
Answer
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👉 Answer:

  • The initial sale is recorded as follows:
    Accounts Receivable     $782.80    
         Sales Revenue     $782.80    


    The firm's records assumed an early payment, but there was no early payment:
    Cash     $824.00    
         Accounts Receivable     $782.80    
         Other Income     $41.20    

👨‍🎓 This is how we solve it:

  1. Remember the formula for the potential discount.
    DOLLAR DISCOUNT = DISCOUNT PERCENT * GROSS COST
  2. Fill in the numbers
    $41.20 = 5% * 824.00
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