Journal entry for discount given to customer

Introduction

In business, we may give a cash discount to customers in order to encourage them to make payment faster. In this case, we need to make the journal entry for discount given to customers when they make payment within the discount period given.

The cash discount is a type of discount that is given to customers when they make payment within a period of time (e.g. 10 days). We need to make the journal entry for this type of discount because the discount is usually only given at some point of time after the credit sale when the customer makes the payment.

On the other hand, we may have another type of discount which is called a trade discount. The trade discount is a type of discount that is usually given to customers when they make a big volume of purchases or make the purchase of certain types of goods (e.g. new products). This type of discount is given at the time of sale and it will be net off with the gross sales amount immediately.

Journal entry for discount given to customer

We can make the journal entry for discount given to customers when they make cash payments within the discount period by debiting the cash account for the net cash account and sales discounts account and crediting the accounts receivable.

Cash discount:

In this journal entry, the sales discounts account is a contra account to the sales revenue on the income statement. Likewise, the journal entry for discount given to the customers here will reduce the net sales for the discount amount given.

Example of cash discount given to customer

For example, on January 31, we make $5,000 sales on credit to one of our customers. We have the 2/10, n/30 term in the sale invoice in which if the customer makes the cash payment within 10 days, there will be a 2% discount given on the sales amount. And the credit term is 30 days which customers will need to pay the cash within 30 days.

Later, on February 8, the customer makes the payment on the credit purchase with the cash of $4,900 ($5,000 – $100) as the 2% or a $100 discount is given.

In this case, on January 31, we can make the journal entry for $5,000 credit sales with the debit of accounts receivable and sales revenue as below:

Credit sale on January 31:

This journal entry increases both total assets on the balance sheet and total revenues on the income statement by $5,000 as of January 31.

Then on February 8, we can make the journal entry for the $100 discount given to customer by debiting this amount to the sales discounts account as below:

Cash discount on February 8:

This journal entry will decrease the net sales revenue on the income statement as well as decrease total assets on the balance sheet by $100 on February 8, for the discount given to customer.

2/10, n/30

The term “2/10, n/30″, or “2/10 net 30” is the credit term that is usually stated on the credit sale invoice. This “2/10, n/30” on the sale invoice means that the due date of the credit is within 30 days. However, if the customers pay within 10 days, a discount of 2% on the gross sale amount will be given.

In other words, if the customers make the cash payment within 10 days, they will save 2% over 20 days (30 days – 10 days) which is equivalent to 36.5% (2% x 365 days / 20 days) of the effective annual rate.

This type of discount given to customers is a good way to encourage them to pay faster as it gives a big percentage of saving to customers if we convert the 2% over 20 days to an effective annual rate. On the supplier’s side, receiving the cash payment from customers faster would make the business operation run smoother and reduce the risk of the customers defaulting on payment.

Estimate the discount given to customer

In accounting, we may also need to estimate the discount given to customers at the end of the accounting period if the discount amount is significant or material to financial statements. This is due to, during the discount period, there is an uncertainty of whether the customer will accept the discount or not.

Hence, we need to estimate the discount given, but not accepted yet by the customer, in order to have an appropriate net sales revenue presented on the income statement. We may do this with historical data and past experience.

Of course, since the discount period is usually short (e.g. 10 days) and the amount is usually not a material figure to the financial statement, it’s usually not an issue that we need to focus on when preparing the financial statement at the end of the accounting period.

Trade discount

As mentioned, a trade discount is a type of discount that is usually given to customers at the time of sale when they make a big purchase or purchase a certain product. Hence, there is no separate journal entry for the trade discount as it will net off with the gross sales.

For example, we give a trade discount of 10% for the customer that makes the purchase of goods from $1,000 up from January 15 to January 31. And on January 31, one of our customers make a cash purchase of $1,000.

In this case, we will receive only $900 from this cash sale as the discount of 10% or $100 is given to the customer at the time of the sale which is on January 31.

Likewise, when we make the journal entry for this $1,000 cash sale on January 31, we will record the net amount of $900 instead of $1,000 as below:

Cash sale on January 31:

Hence, there is no journal entry for a $100 trade discount as we already net off this amount with the $1,000 sale resulting in only one journal entry above.