In order to encourage early payment, each business normally provides a sales discounts if customers make payment within the discount period.
In this article, we cover the accounting for sales discounts. This includes the journal entry for sales discounts with or without allowance for sales discount account.
Now let’s get started!
What are Sales Discounts?
Sales discounts are also known as cash discount. It is a reduction in credit sales if customers make the payment within the discount period. The term for the cash discount is commonly written as 2/10, n/30. In this term, if customers make payment within 10 days, they receive a cash discount of 2% and the credit period is 30 days.
Is Sales Discount a Debit or Credit?
As mentioned above, sales discounts is a reduction in credit sales. It is a sales discount contra account. Therefore, sales discount is recorded on debit.
Presentation of Sales Discounts
The sales discounts are presented in the income statement as a reduction in sales the same way as sales return and allowances. In the single-step income statement, sales discounts are deducted from sales and presented net off as net sales.
In contrast, in the multiple-step income statement, sales discounts presented separately as a reduction in sales.
Below is the extract section of sales discount:
| Sales | XXX | |
| Less: Sales discount | XXX | |
| Sales returns and allowances | XXX | XXX |
| Net sales | XXX |
Accounting for Sales Discounts
Sales discount accounting is straightforward. As it is a reduction in sales, sales discounts are recorded on the debit side. Below is the sample journal entry to record the sales discounts:
| Account Name | Debit | Credit |
|---|---|---|
| Cash | XXX | |
| Sales discounts | XXX | |
| Accounts receivable | XXX |
Some companies created an allowance account to record the sales discount when the potential cash discount would happen in the next accounting period. In this case, the discount should be estimated and allowance on sales discounts should be provided for at the year-end.
Below is the journal entry for the allowance on sales discounts:
| Account Name | Debit | Credit |
|---|---|---|
| Sales discount | XXX | |
| Allowance for sales discounts | XXX | |
| (To record the allowance for sales discounts) |
If customers make payment within the discount period provided, the allowance for sales discounts is reversed by recording at the debit side as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Cash | XXX | |
| Allowance for sales discounts | XXX | |
| Accounts receivable | XXX | |
| (To record the customers’ payment and reverse the allowance for sales discounts) |
However, if the customers do not take the advantage of the cash discount and make payment after the discount period, thus the allowance for sales discount is to be reversed. The journal entry for the reversal of allowance on sales discounts is as follows:
| Account Name | Debit | Credit |
|---|---|---|
| Cash | XXX | |
| Allowance for sales discounts | XXX | |
| Sales discount forfeit | XXX | |
| Accounts receivable | XXX | |
| (To record the customers’ payment and reverse the allowance for sales discounts) |
In order to illustrate this, let’s go through the example below.
Example 1
ABC Co sold its merchandise inventory to its customer on 01 November 20X1 for $2,000 with the credit term of 2/10, n/30.
Note: In the journal entries below, we ignore the merchandise inventory and cost of goods sold for simplifying illustration.
Below is the journal entry to record the sales of merchandise inventory:
| Account Name | Debit | Credit |
|---|---|---|
| Sales | $2,000 | |
| Accounts receivable | $2,000 | |
| (To record sales on credit) |
Assume that the customer makes the payment on 09 November 20X1, the customer would receive a cash discount of $40 ($2,000 × 2%). Thus, the customer will need to pay only $1,960. Below is the journal entry at the time of payment within the discount period:
| Account Name | Debit | Credit |
|---|---|---|
| Cash | $1,960 | |
| Sales discounts | $40 | |
| Accounts receivable | $2,000 | |
| (To record payment from customer with cash discount) |
However, if the customer makes the payment on 15 November 20X1 which is after the allowable discount period, thus, the customer would not receive the sales discount; therefore, ABC Co would receive the full payment from its customer.
Below is the journal entry for full payment:
| Account Name | Debit | Credit |
|---|---|---|
| Cash | $2,000 | |
| Accounts receivable | $2,000 | |
| (To record full payment from the customer) |
Example 2
Let’s assume that XYZ Company sells construction materials. On 25 December 20X1, it sells construction materials to one of its customers for a total of $50,000. This customer always buys the construction materials from the company. XYZ Company offers a credit term of 2/10, n/60. This means that if the customer makes payment within 10 days, the company will offer cash discounts of 2% with a credit period of 60 days.
Let’s further assume that XYZ prefers to record the allowance for the sales discounts because it wants the expenses incurred (discount allowed) is recorded at the same time as sales revenue, matching principle. Therefore, the journal entry would be as follow:
Note: We ignore the inventory and cost of goods sold in this illustration.
| Account Name | Debit | Credit |
|---|---|---|
| Accounts receivable | $50,000 | |
| Sales discounts | $1,000 | |
| Allowance for sales discounts | $1,000 | |
| Sales | $50,000 | |
| (To record sales on credit and allowance on sales discounts) |
If the customer makes payment within the discount period, the journal entry would be as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Cash | $49,000 | |
| Allowance for sales discounts | $1,000 | |
| Accounts receivable | $50,000 | |
| (To record payment from customer with cash discount) |
However, if the customer does not make payment within the discount period, the sales discount is forfeited and the allowance for sales discounts should be reversed. Below is the journal entry to record the payment after the discount period:
| Account Name | Debit | Credit |
|---|---|---|
| Cash | $50,000 | |
| Allowance for sales discounts | $1,000 | |
| Sales discount forfeit | $1,000 | |
| Accounts receivable | $50,000 | |
| (To record the customers’ payment and reverse the allowance for sales discounts) |
The Bottom Line
Sales discount accounting is straightforward. Most companies do not allow for cash discounts while some companies allow in order to encourage early settlement. However, the sales discount is considered minimal; therefore, we often recorded at the time of payment if the customer makes payment within the discount period.
Some companies create an allowance account to record the sales discount even though the customer has not made the payment. This is because they want to recognize the discount allowed (expense) in the same period of sales to be in accordance with the matching principle.
