A sales discount is an offer made to a buyer by a seller to pay less than is the actual value within a specified period. It is a reduction in the price of a commodity or service sold to a customer so long as the customer honors the sales invoice with a specified time frame. Sales discounts are beneficial to both buyers and sellers as the buyer gets to pay less while the seller gets his/her money sooner.
Manufacturers use sales discounts in their deals with retailers. Retailers seldom use cash to pay for purchases from manufacturers. In most cases, a retailer has an account or an agreement with the manufacturer for buying commodities. Manufacturers extend sales discounts to the retailers in a bid to incentive them to pay early.
Sales discounts can also be applied to cash sales where a buyer can pay less so long as he/she pays immediately.
An example of a sales discount
Many businesses use a 2% cash discount. An example of a sales discount expressed in a sales invoice would look like 2/10 net 30 which implies that the buyer can pay 2% less of the cost price if he can settle the debt within 10 days. If the 10-day discount offer is not honored, then the expressed terms compel the buyer to settle the whole undiscounted debt within 30 days since the invoice date.
Accounting for a sales discount
A sales discount, if the buyer takes it, represents a reduction in net profit, no matter how small. Businesses have two ways to account for sales discounts: the net method and the gross method.
The gross method – in this method, the seller is unsure whether the buyer will take the sale discount. When it is taken, the discount is recorded as a debit in the sales discount account and consequently as a credit in the accounts receivable account. The sales discount is represented in the income statement as contra-revenue implying it reduces gross sales and by extension the net sales.
The net method – in this method, the seller assumes that the sales discount is always taken and records the purchased goods at the discounted price. If it happens that the discount is not taken, then it is lost and the seller has to make an entry reversing the discounted amount in the purchase entry. The choice to use the net method is usually taken when the discounted amount is too little that offering the discount sales and gross sales separately doesn’t show much difference to just offering the net sales in the income statement.