What is cash discount? & Accounting entries

What is a cash discount?

When goods are bought on credit the buyer is expected to pay the seller within the time agreed upon.Often the credit terms are thirty,sixty, or ninety days.To encourage the buyer to make payment before the end of the credit period, the seller  may allow a deduction from the amount owed. A deduction that the seller allows on the amount of an invoice to encourage the purchaser to make prompt payment is known as a cash discount.

The cash discount taken by the buyer is called a discount on purchases and a cash discount granted to a customer is known as discount on sales.Discount on sales is allowed,while discount on purchases is discount received.Discount allowed to customers ( debtors) is a business expense, discount received from suppliers ( creditors) is a business income.

Important thing to note, is that the cash discounts are not actually received or paid in cash.They are only adjustments made in the accounts.

What are trade discounts?

Accounting entries for Cash discounts

Let’s go through an example, X Ltd is a regular customer of  Y Ltd. On  01-08-2016 Y Ltd sold goods to X Ltd amounting  5000. The normal credit period is 30 days which means the bill is due on 31-08-2016. But Y Ltd gives a a  2 %10 net 30 discount. 

2/% 10 NET 30 is a common term used to abbreviated payment term. It is expanded as 2% cash discount if paid within 10 days. Net payment period is 30 days but no discount after 10 days.

Assume that X Ltd is paying on 10-08-2016 with discount, The accounting entries or journal entries for the cash discount transactions is as follows.

What is early payment discount?

When a discount is allowed:

In the books of Y Ltd the cash discount is booked as follows.It is an expense to Y Ltd.

Y Ltd
JOURNAL
Date	Particulars	JF	Debit	Creidt
10/8/2016	Discount Allowed A/c …..Dr		100
	To; X Ltd			100
	( Cash discount is given 2% 10 net 30 basis)

 

When discount is received : 

For X Ltd discount received is an Indirect  Income, This is booked as follows.

X Ltd
JOURNAL
Date	Particulars	JF	Debit	Creidt
10/8/2016	Y Ltd………………..Dr		100
	To; Discount Received A/c			100
	( Cash discount received 2% 10 net 30 basis)

 

Closing Entry of cash Discount Allowed

At the time of closing books of entry the following entry is passed to close the discount allowed account.

Difference between Cash discount and trade discount

Note: While making closing entry the Net balance of the Account is transferred.That is the net balance from 01-04-2016 to 31-03-2017 as per our example we have only one entry in both the ledger.

Y Ltd
JOURNAL
Date	Particulars	JF	Debit	Creidt
31/03/2017	Profit & Loss Account …..Dr		100
	To; Discount Allowed A/c			100
	( The total of  discount allowed is transferred to profit and loss account )

Closing Entry For Cash Discount Received

At the end of the Financial year the total of discount received by X Ltd is transferred to P & L Account and the discount received account is closed.

X Ltd
JOURNAL
Date	Particulars	JF	Debit	Creidt
31/03/2017	Discount Received A/c …..Dr		100
	To; Profit & Loss Account			100
	( The total of  discount reeived is transferred to profit and loss account )

Cash Discount & Profit and Loss Account

Based on the above entry we can report the Discount received and discount allowed to profit and loss account.

Discount received on Profit & Loss account.

X Ltd
Profit And Loss Account as on 31-03-2017
Expense	Amount	Income	Amount
Opening Stock	xxxx	By sales	xxxx
Purchase	xxxx	closing Stock	xxxx
Carriage	xxxx
Manufacturing Wages
Gross profit c/d	xxxx
	xxxx		xxxx
		By gross profit b/d	xxxx
Rent	xxxx	Discount received	100
Office salary	xxxx
Electricity	xxxx
Bad debts	xxxx
		Net Profit	xxxx
	xxxx		xxxx

Discount Allowed on Profit & Loss Account

Y Ltd
Profit And Loss Account as on 31-03-2017
Expense	Amount	Income	Amount
Opening Stock	xxxx	By sales	xxxx
Purchase	xxxx	closing Stock	xxxx
Carriage	xxxx
Manufacturing Wages
Gross profit c/d	xxxx
	xxxx		xxxx
		By gross profit b/d	xxxx
Rent	xxxx	Discount received	xxxx
Office salary	xxxx
Discount Allowed	100
Electricity	xxxx
Bad debts	xxxx
		Net Profit	xxxx
	xxxx		xxxx

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