Cash discount is the term quite common in sales made to customers on credit terms. As we know that very few customers hardly pay on the spot of the transaction. So, they negotiate with the company the possible credit terms to pay off their liabilities.
On the other hand, company wants to collect its receivables as early as possible to improve its working capital. In order to achieve this, company gives cash discount to customers such as 2% discount to the customer if it pays within 10 days after the sale transaction. In accounting terminology, this is written as 2/10, n/25. It means that the customer has to pay the outstanding amount within 25 days after sales. But if it pays within 10 days, it will get 2% discount on the sale amount.
Cash discount is the term used when the creditor offers the debtor to make early payment. As a result, the creditor allows some discount for early payment. This discount is termed as cash discount. In business world, another type of discount is the trade discount which is quite common. Almost every creditor gives trade discount to its customers.
Difference between cash discount vs trade discount
| Cash discount | Trade discount |
| 1. this is not normal in business dealing,2. the creditor offers a good percentage as the discount. This is up to debtor whether it wants to claim this facility. For example, credit term with a creditor is 30 days. However, if debtor pays within 10 days from the receipt of the goods, he will enjoy a 10 % discount.3. this is the best tool to receive payment quickly.4. it is not shown in the invoice or bill as it depends upon the decision of the debtor whether it wants to exercise this option. 5. it is given at the time of making the payment.6. cash discount may not be given to all customers. | 1. this is normal practice in business transactions,2. the creditor offers certain products at a price, but after negotiation reduces the price by some percentage, such as by 1 or 2 %.3. it is the need of the creditor to give certain percentage of discount due to market norms, otherwise debtor has so many options with other parties in the market.4. it is clearly shown in the invoice or bill sent to the debtor.5. as the parties in the transaction mutually agree for the trade discount amount, it is given at the time of purchase of goods.6. trade discount is allowed to every customers because it is the norm of the business. |
Cash discount accounting treatment
In order to properly account for cash discount, there are two methods which you can use:
1. Gross method of accounting for cash discounts
Under this approach, the buyer records the full amount of the invoice in its accounting records. If the buyer avails the cash discount by making payment in short period of time, it then records the purchase discount. Journal entry would be as follows:
| Particulars | Debit | Credit |
| At the time of purchase of goods:Purchase Accounts payable | xxx | xxx |
| At the time of making payment and availing cash discount:Accounts payableCashPurchase discount | xxx | xxxxxx |
| However, if the payment is made after the due date for cash discount, the entry will be:Accounts payableCash | xxx | xxx |
2. Net method of accounting for cash discounts
Under this approach, the accounts payable are recorded after deducting the cash discount, that is why this method is called net method of cash discount. Journal entries will be as follows:
| Particulars | Debit | Credit |
| At the time of purchase of goods:Purchase Accounts payable | xxx | xxx |
| At the time of making payment and availing cash discount:Accounts payableCash | xxx | xxx |
| However, if the payment is made after the due date for cash discount, accountant has to record purchase discount lost:Accounts payablePurchase discount lostCash | xxxxxx | xxx |
Example
ABC sells furniture amounting $10,000 to its customer on credit terms of 2/10 n/20. Journalize the transaction if the customer pays in 8 days using the gross method and net method of recording cash discount.
Solution
Gross Method:
| Debit | Credit | |
| Accounts Receivable | 10,000 | |
| Sales | 10,000 | |
| Cash | 9,800 | |
| Sales Discount | 200 | |
| Accounts Receivable | 10,000 |
Net Method
| Debit | Credit | |
| Accounts Receivable | 9,800 | |
| Sales | 9,800 | |
| If customer pays in 10 days: | ||
| Cash | 9,800 | |
| Accounts Receivable | 9,800 | |
| If customer pays after 10 days: | ||
| Cash | 10,000 | |
| Accounts Receivable | 9,800 | |
| Sales Discount Forfeited | 200 | |