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What is cash discount? & Accounting entries

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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

Hope the concept of cash discount and its accounting is clear for you.Please do share our post if you like it.

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