There are two types of purchase discounts and the accounting treatment for these two discounts is different from one and another. These are cash discount and trade discount.
In this article, we cover the accounting for cash purchase discounts. This includes the illustration of the net method vs gross method of recording purchase discounts both under the perpetual inventory system and periodic inventory system.
Let’s get started!
What is Purchase Discounts?
The cash purchase discounts refer to the discount received when a business settles the payment within the credit term. This typically terms as, for example, 2/10, n/30. In this term, it means that the business would receive a cash discount of 2% if the business makes payment within the credit term of 30 days.
Accounting for Purchase Discounts: Net Method vs Gross Method
Accounting for purchase discounts, we can be recorded under either the net method or the gross method. Both methods provide the same result; however, the accounting journal entry is slightly different.
In the gross method, we normally record the purchase transaction at a gross amount. The amount is shown on the invoice. This method ignores any cash discount as per the agreed term.
However, in the net method, we record the purchase transaction at the net amount assuming that the payment would be made exactly on or before the agreed credit term. In this method, the amount of purchase recorded is the amount of invoice minus the cash discount.
In order to illustrate precisely accounting for purchase discounts, let’s assume that ABC Co purchases merchandise inventory from its supplier on November 02, 20X1 at the original invoice amount of $1,500. The term of the payment is 2/10, n/30.
Thus, in the below section, we illustrate the journal entry to record this purchase transaction from the date of purchase until the date of purchase both receiving a discount and not receiving a discount. The illustration would also illustrate under both perpetual and periodic inventory systems.
Under Perpetual Inventory System
In this section, we illustrate the journal entry for the purchase discounts for both net method vs gross method.
Journal Entry at Purchase Date
Below is the journal entry of the purchase of merchandise at the purchase date under the gross method and net method:
Gross Method
In the gross method, we record the merchandise inventory at the original invoice amount. Below is the journal entry under gross method:
| Account Name | Debit | Credit |
|---|---|---|
| Merchandise inventory (Gross) | $1,500 | |
| Accounts payable | $1,500 |
Net Method
In the net method, we record the purchase at the amount less the purchase discounts. From the above example, the amount of purchase is $1,500. If ABC Co makes payment within the discount period, ABC would receive a discount of $30 ($1,500 × 2%). Therefore, the journal entry under the net method is as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Merchandise inventory (Net) | $1,470 | |
| Accounts payable | $1,470 |
Journal Entry at the Date of Payment within the Discount Period
If the company makes the payment on this purchase within 10 days as per the credit term, the company would receive the cash discount. Thus, below is the journal entry at the date of payment within the allowed credit term:
Gross Method
In this method, the discount received is recorded as the reduction in merchandise inventory. Therefore, the amount of discount is recorded on credit to the merchandise inventory account.
Below is the journal entry to record the purchase discount:
| Account Name | Debit | Credit |
|---|---|---|
| Accounts payable | $1,500 | |
| Merchandise inventory | $30 | |
| Cash | $1,470 |
Net Method
Unlike the gross method, in the net method, we record the cash payment equal to the accounts payable account that the company recorded a net at the date of the purchase transaction. Therefore, the journal entry would be as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Accounts payable | $1,470 | |
| Cash | $1,470 |
Journal Entry if Payment Made after Discount Period
However, if the invoice is not paid within the discount period, an adjusting entry needs to be made under the net method in order to recognize the loss on the discount. By recording this adjustment, the accounts payable need to be adjusted back to the full invoice amount.
In contrast, there is no journal entry is required under the gross method as the transaction was recorded at the gross amount at the date of purchase and the company would make the full payment without the discount.
Therefore, under the net method, we can record the journal entry as follow in order to recognize the discount loss on the purchase as a result of failing to make payment within the discount period:
| Account Name | Debit | Credit |
|---|---|---|
| Discount lost | $30 | |
| Accounts payable | $30 |
Hence, the total accounts payable become a total of $15,000 ($1,470 + $30) the same as the original invoice amount.
Journal Entry at the Date of Payment over Discount Period
Lastly, at the time of making payment (failing to get the advantage of cash discount), the journal entry to record the payment under both net and gross method are the same. This is because the amount of accounts payable that the company needs to make payment to the supplier under both methods is at the same amount.
Below is the journal entry to record the payment under both net and gross method without discount received:
| Account Name | Debit | Credit |
|---|---|---|
| Accounts payable | $1,500 | |
| Cash | $1,500 |
Under Periodic Inventory System
In this section, we illustrate the journal entry for the purchase discounts for both net methods vs gross method under the periodic inventory system.
Journal Entry at Purchase Date
Below is the journal entry of the purchase of merchandise at the purchase date under the gross method and net method:
Gross Method
In the gross method, we record the purchase of merchandise inventory into the purchase account at the original invoice amount.
Below is the journal entry:
| Account Name | Debit | Credit |
|---|---|---|
| Purchases | $1,500 | |
| Accounts payable | $1,500 |
Net Method
In the net method under the periodic inventory system, we record the purchase at the amount less the purchase discounts to the purchase account. From the above example, the amount of purchase is $1,500. If ABC Co makes payment within the discount period, ABC would receive a discount of $30 ($1,500 × 2%). Therefore, the journal entry under the net method is as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Purchases | $1,470 | |
| Accounts payable | $1,470 |
Journal Entry at the Date of Payment within the Discount Period
If the company makes the payment on this purchase within 10 days as per the credit term, the company would receive the cash discount. Thus, below is the journal entry at the date of payment within the allowed credit term:
Gross Method
In this method, the discount received is recorded into the purchase discounts account. Therefore, the journal entry to record the purchase discounts is as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Accounts payable | $1,500 | |
| Purchase discounts | $30 | |
| Cash | $1,470 |
At the end of the accounting period, the company needs to calculate the cost of goods sold by taking into account the purchase discounts.
Net Method
Unlike the gross method, in the net method, we record the cash payment equal to the accounts payable account that the company recorded a net at the date of the purchase transaction. Therefore, the journal entry would be as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Accounts payable | $1,470 | |
| Cash | $1,470 |
This journal entry is the same as the perpetual inventory system.
Journal Entry if Payment Made after Discount Period
The same as the perpetual inventory system, there is a journal entry needed under the gross method to record the adjustment of discount lost. However, under the net method, we need to record adjusting entries to recognize the loss of the discount.
Therefore, under the net method, we can record the journal entry as follow in order to recognize the discount loss on the purchase as a result of failing to make payment within the discount period:
| Account Name | Debit | Credit |
|---|---|---|
| Discount lost | $30 | |
| Accounts payable | $30 |
Hence, the total accounts payable become a total of $15,000 ($1,470 + $30) the same as the original invoice amount.
Journal Entry at the Date of Payment over Discount Period
Lastly, the same as the perpetual inventory system, at the time of making payment (failing to get the advantage of cash discount), the journal entry to record the payment under both net and gross method are the same. This is because the amount of accounts payable that the company needs to make payment to the supplier under both methods is at the same amount.
Below is the journal entry to record the payment under both net and gross method without discount received:
| Account Name | Debit | Credit |
|---|---|---|
| Accounts payable | $1,500 | |
| Cash | $1,500 |
Conclusion
The journal entry to account for purchase discounts is different between the net method vs the gross method. In the gross method, we record the purchase transaction at the original invoice amount while we record at the net of discount received under the net method.
