Definition
The term cash discount is used to describe a deduction offered by sellers to buyers of goods and services if payment is made within a certain timeframe. Cash discounts are offered to encourage buyers to pay for the goods or services before the due date specified on the invoice.
Calculation
Price Paid = Invoice Price - (Cash Discount x Invoice Price)
Explanation
While the seller of the goods or services may also refer to a cash discount as a sales discount, buyers may refer to this offer as a purchase discount. In a business-to-business setting, the invoice rendered by the seller will indicate when the money is due. For example, the invoice might state: Payable in 60 days.
Companies will offer cash discounts to buyers to lower accounts receivable, reduce days sales outstanding (DSO), and speed up the cash conversion cycle. In doing so, the company makes better use of its cash assets. Sellers would record these discounts on the income statement as a contra-revenue account (Sales Discounts).
Cash discounts are oftentimes communicated on invoices, and usually take the following form:
5/14, Net 60
The above would be translated as: 5% discount if paid within 14 days, the net amount is due in 60 days.
Gross Method
Cash discounts are accounted for by companies using either the gross or net methods. Under the gross method, the sale is recorded at its gross value, before the discount offered. In this example, a credit sale for $100 is made; with the offer of a cash discount of 5% if payment is made in 10 days.
Debit | Credit | |
Accounts Receivable | $100 | |
Revenues | $100 |
If payment is made within 10 days, the transaction is recorded as:
Debit | Credit | |
Cash | $95 | |
Sales Discounts | $5 | |
Accounts Receivable | $100 |
If the customer does not take advantage of the discount, the transaction is recorded as:
Debit | Credit | |
Cash | $100 | |
Accounts Receivable | $100 |
Net Method
Companies using the net method will record the sale at the net amount, assuming the customer will take full advantage of the discount offered:
Debit | Credit | |
Accounts Receivable | $95 | |
Revenues | $95 |
If payment is made within 10 days, the transaction is recorded as:
Debit | Credit | |
Cash | $95 | |
Accounts Receivable | $95 |
If the customer does not take advantage of the discount, the transaction is recorded as:
Debit | Credit | |
Cash | $100 | |
Sales Discounts Forfeited | $5 | |
Accounts Receivable | $95 |
Example
Company A's list price for a widget is $200. Company XYZ has purchased 10 widgets. The invoice received from Company A indicates a cash discount of 2/10, Net 30. Company XYZ plans to take advantage of this offer, and submits payment within 10 days. The amount paid by Company XYZ would be calculated as:
Quantity | Item | Unit Price |
10 | Red widget, with Company XYZ Logo | $200 |
Subtotal | $2,000 | |
Less: Cash Discount (2%) | -$40 | |
Total Due | $1,960 |
Company A uses the gross method, and records the initial transaction as:
Debit | Credit | |
Accounts Receivable | $2,000 | |
Revenues | $2,000 |
Since Company XYZ paid in less than 30 days, the transaction was recorded as:
Debit | Credit | |
Cash | $1,960 | |
Sales Discounts | $40 | |
Accounts Receivable | $2,000 |
Related Terms
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- The financial accounting term receivables is used to describe the claims a company has against customers and others for the future collection of cash, goods, or services. Receivables are classified as an asset, and will appear on the company's balance sheet.Moneyzine EditorSeptember 21st, 2023
- The term trade discount is used to describe the amount by which the list price of an item is reduced when selling to a business that will eventually resell the item. Trade discounts are used to mask the true invoice price from competitors, simplify pricing in brochures and catalogs, as well as reward high volume resellers.Moneyzine EditorSeptember 21st, 2023
