Is Sales Discount Debit or Credit?
Is sales discount debit or credit? When companies sell goods or render services, they may offer sales discount. These transactions have to be recorded on financial statements; therefore, we will discuss how to record sales discounts as debits or credits. Before you understand whether a sales discount is a debit or credit, it is proper to have a good knowledge of all these terms: sales discount, debits, credits, and double entry booking keeping in accounting.
With the sales discount, the company offers the customer the chance to pay an amount that is lesser than the invoice amount for the goods or services received provided the customer pays within a specified period. This allows the company to get paid for their goods or services in good time and the customer gets a bargain by paying less.
The sales discount account reduces a company’s total revenue, it is therefore said to be a contra-revenue account and is a debit. Giving a sales discount is one of the ways companies maintain their customers, encourage more patronage or reward early payment for goods or services received.
A sales discount has an impact on the revenue figures that will be recorded in a company’s income statement. When customers take advantage of a sales discount by paying early for the goods or services they have received, the overall revenue of the company is reduced but this reduction in revenue is a good thing for the company since it reduces its debt profile.
Any transaction that occurs in a company is recorded in the company’s balance sheet in a dual entry which is referred to as double-entry bookkeeping. Generally, a debit is recorded on the left column of the balance sheet while a credit is recorded on the right column of the same. This is to ensure accuracy and balance in the financial records of the company.
In order to have accurate reports on all sales discounts, it is important to understand what it means and how it is recorded. Here, we shall discuss why a sales discount is a debit and not credit and the various journal entries for it.
What is a sales discount?
A sales discount is usually a percentage reduction in the cost of goods or services if they are paid for within a stipulated time frame. The main goal of companies who give the sale discount is to clear their accounts receivable in time and reduce the number of accounts that stay for a long period before being cleared up.
For instance, a company invoice that has “3/7 net 30” means that the customer can get a three percent (3%) discount if they pay the invoice within seven (7) days of the invoice date or they can pay the whole invoice amount by the normal payment date which is thirty (30) days after the invoice.
The sales discount normally encourages customers to pay for goods and services early as they get rewarded by the discount they get upon the early payment. Sales discounts are contra revenue and are recorded separately from invoices and are usually included in the company’s sale activity.
In simple terms, a sales discount is a reduction in the amount a customer owes a company. The sales discount is dependent on the credit terms that the company offers its customers which allows them to pay a certain percentage lesser for goods and services. Sales discounts usually come with a fixed time or date for the customer to make the payment. When the customer does not pay for the goods or services within the stipulated discount time frame or date, the price reduction becomes forfeited.
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The sales discount account
The sales discount account is a contra-revenue account. A contra-revenue account is an account that records a deduction from the gross revenue of a company; this usually results in net revenue. When recording a contra revenue, there are three different accounts that could be used which are:
- The sales discount account contains the amount of sales discount given to customers in exchange for early payments of invoices.
- The sales allowance account contains the actual amount of allowance associated with specific sales or an allowance for price reductions for the company’s products that has minor defects.
- The sales returns contain the actual amount of revenue associated with goods that have been returned or an allowance for returned goods.
Although all these are contra-revenue accounts, our focus here shall be on the sales discount.
When there is a sales discount, the customer pays less than the invoice amount. For example, if John buys 5 computers from Company ABC at $1,000 per computer and the terms were 2/10 net 30. It means that instead of paying $5,000 for the computers, John gets a 2% discount if he pays in 10 days. That is, he will pay $4,900 ($5,000 total cost of computers minus $100 sales discount) if he makes payment within 10 days. If however, John does not pay for the computers within ten days, then he will pay the complete $5,000.
If John pays for the computers within 10 days, the company will record the transaction as follows
| Account | Debit | Credit |
|---|---|---|
| Cash | $4,900 | |
| Sales discount | $100 | |
| Accounts receivable | $5,000 |
If a company expects that most of its customers will take the sales discount offered, then it will need to create a sales discount reserve. The sales discount reserve is created based on an estimation of the number of discounts that will probably be taken by the customers.
At the end of each month, there is a debit to the sales discount contra account and a credit to the sales discount reserve. As the discounts are taken, the accounts receivable account is credited with the same amount which is the sales discount that has been debited from the sales discount account. By so doing, the sales discount is recognized in the same period as the invoices such that all aspects of the sale are recognized and harmonized at once.
Debit and credit explained
A debit is an accounting entry that reduces revenue, equity, or liability account or adds to an asset or expense account. Debits are usually placed on the left column of the accounting entry. A credit is an accounting entry that reduces an asset or expense account or increases a revenue, equity, or liability account. Credits are usually placed on the right column of an accounting entry.
When recording financial transactions, companies use the double-entry bookkeeping method whereby for every debit, there will be an equal but opposite credit. And for every credit, there is also an equal but opposite debit. Companies make use of different accounts for their various transactions, these accounts include:
- Assets comprise resources both tangible and intangible assets that bring positive economic value to the company.
- Expenses comprise all costs incurred from the company’s operations. This includes wages, cost of supplies, etc.
- Liabilities which is a record of all the company owes creditors such as the accounts payable.
- Equity comprises the company’s income from the sale of common and preferred stock and its retained earnings.
- Revenue/Income comprises all monies that the company earns.
There can be some confusion about the inherent meaning of debits and credits because they affect different accounts in different ways. For each of the accounts mentioned above, debits and credits affect them in different ways as shown in the table below:
| Account | Debit | Credit |
|---|---|---|
| Assets | Increases the balance | Decreases the balance |
| Expenses | Increases the balance | Decreases the balance |
| Liabilities | Decreases the balance | Increases the balance |
| Equity | Decreases the balance | Increases the balance |
| Revenue/Income | Decreases the balance | Increases the balance |
The key thing to remember is that debits are recorded on the left column while credits are recorded on the right column of an accounting entry. Additionally, the entries are mostly dual with one being debit and another being credit. Below is an example of how a debit and credit entry for a sales discount would look like.
| Date | Account | Debit | Credit |
|---|---|---|---|
| 01/01/2022 | Sales discount | 1000 | |
| Account receivable | 1000 |
See also: Where is accumulated depreciation in the balance sheet?
Is sales discount a debit or credit?
Accounting for sales discount debit or credit
As stated earlier, a sales discount is a reduction in the price a customer pays for goods or services received. The sales discount is usually offered by companies to encourage early payments for the goods sold or services rendered. If a customer takes advantage of the sales discount offered, the company records the sales discount as a debit and credits the accounts receivable.
The sales discount is recorded in the income statement of a company. When a sales discount is recorded in the income statement, it reduces the company’s gross sale amount thereby resulting in a smaller net sales figure. Below is an example of how a sales discount will appear in a company’s income statement assuming the invoice was written within the same accounting period as when the customer makes a payment.
| Account | Amount |
|---|---|
| Gross sale | AAAA |
| Less: sales discount | (BBBB) |
| Net sales | CCCC |
Some companies do not record gross sales and sales discounts in their income statement especially when the sales discount amount is small.
In a situation where a company has offered discounts to several customers, the record for such sale discount will vary from the one given above. If for instance the invoice for a sales discount was offered to customers who made purchases at the end of a month, the customers will pay for these goods in the next month. This will make the invoice and the sales discount fall within two different accounting periods which could pose a challenge for accounting purposes. Based on the matching principle in accounting, any related transactions have to be recorded within the same accounting period. Hence when revenue is reported, any matching expenses have to be reported as well within the same accounting period.
In order to avoid the challenges that may arise as a result of the invoice and the sales discount payment falling in two different accounting periods, an estimate of what the sales discount will be is recorded. The sales discount account will be debited by the estimated discount amount and the allowance for the sales discount account will be credited with the same amount as shown in the table below.
| Account | Debit | Credit |
|---|---|---|
| Sales discount | 1111 | |
| Allowance for sales discount | 1111 |
The essence of crediting the allowance for sales discount account with the discount amount in the same accounting period as that of the invoice date is to be able to report the estimated sales discount amount at once thereby ensuring the company’s balance sheet is balanced.
When the customer pays the discounted amount in the next accounting period, the cash and allowance for sales discount accounts will be debited while the accounts receivable will be credited. The journal entry that will record the payment will be the same as the one below
| Account | Debit | Credit |
|---|---|---|
| Cash | AAAA | |
| Allowance for sales discount | BBBB | |
| Accounts receivable | CCCC |
From the table above, we can see that once the customer takes the discount, the allowance for the sales discount account is debited. Thus, it avoids having to impact the company’s income statement due to the different accounting periods.
When a company makes a sale that carries a sales discount of say 10/10 net 30, the company does not record the discount immediately, instead, the sale is reported as a debit to the accounts receivable and a credit to the sales account as shown below
| Account | Debit | Credit |
|---|---|---|
| Accounts receivable | 1111 | |
| Sales | 1111 |
When a payment is made by a customer that has met the terms of a sales discount, the amount paid on the invoice is revenue to the company and is recorded as cash while the amount that has been discounted is recorded under the sales discount account. For such payment, three accounts are involved in the recording process which are the cash, sales discount, and accounts receivable accounts.
The sales discount amount is usually subtracted from the total invoice amount to determine how much a customer will pay if they took advantage of the sales discount. When the customer pays, within the stipulated discount period, the cash account is debited by the amount that was paid by the customer. The discount given is debited in the sales discount account while the sum of the amounts that have been debited in the cash and sales discount account is credited to the accounts receivable.
By debiting the cash and sales discount accounts, these two accounts get increased while crediting the accounts receivable decreases the account. The journal entry for the sales discount will look like the one below
| Account | Debit | Credit |
|---|---|---|
| Cash | AAAA | |
| Sales discount | BBBB | |
| Accounts receivable | CCCC |
The amount paid as cash is usually lesser than the invoice amount which is recorded under the accounts receivable hence the need to debit the sales discount account. Doing this ensures that the debits and credits as well as the entire financial record are balanced.
If the customer does not make the payment within the period of the sales discount, they will have to pay the complete invoice amount and this will be recorded just as the journal entry for when the goods were first sold as shown below.
| Account | Debit | Credit |
|---|---|---|
| Accounts receivable | 1111 | |
| Sales | 1111 |
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Sales discount debit or credit examples
So far, we have seen that the sales discount is a debit and not credit because it is a contra-revenue account. Now, we will look at various hypothetical scenarios of how sales discount accounting works.
Example one
Suppose Mike is a retail shoe seller who buys his shoes in bulk from a shoe manufacturing company and resells them later on. If he bought shoes worth $200,000 and the company offers him a five percent (5%) sales discount if he pays for the shoes in ten (10) days.
After the sale, the company will record the sale as a debit to the accounts receivable and a credit to the sales account as follows
| Account | Debit | Credit |
|---|---|---|
| Accounts receivable | $200,000 | |
| Sales | $200,000 |
If Mike takes advantage of the sales discount offered and pays for the shoes within ten days, he gets a 5% discount meaning that instead of paying $200,000, he will pay $200,000 x 0.05 which is $190,000. The shoe manufacturing company will then record the sale with the paid sum as a debit to the cash account, the $10,000 discount will be debited from the sales discount account and the full invoice amount will be credited to the accounts receivable as follows
| Accounts | Debit | Credit |
|---|---|---|
| Cash | $190,000 | |
| Sales discount | $10,000 | |
| Accounts receivable | $200,000 |
When the shoe company records this discount in the revenue section of its income statement, it will look like the table below if the transaction and the payment were both carried out within the same accounting period.
| Account | Amount |
|---|---|
| Gross sale | $200,000 |
| Less: sales discount | ($10,000) |
| Net sales | $190,000 |
Example two
Mercy purchased goods worth $90,000 from a company on credit. But on the invoice, she noticed the terms as 10/10 net 30. Meaning that she has 30 days to settle the invoice but if she settles it in 10 days, she will get a 10% sales discount on the goods she bought. If Mercy takes advantage of the sales discount and settles the invoice within 10 days, instead of paying $90,000 for the goods, she will pay $90,000 x 0.10 which is $81,000. When she pays, the company will record it as follows
| Accounts | Debit | Credit |
|---|---|---|
| Cash | $81,000 | |
| Sales discount | $9,000 | |
| Accounts receivable | $90,000 |
If the ten-day period passes and Mercy is unable to settle the invoice, it means that she is no longer eligible for the discount and will have to pay the full invoice amount of $90,000
Conclusion
The sales discount is a debit because it is a contra-revenue account. A sales discount is a percentage reduction offered to customers by companies for goods or services. It requires that the customers pay for the goods or services within the stated period on the invoice in order to get the discount.
Companies use sales discounts to aid their cash management and reduce bad debts. This is because customers are encouraged to pay invoices on time due to the time restriction that sales discounts have. Consequently, when invoices are paid up in a timely manner, it improves the company’s cash flow and reduces invoice aging.
Understanding how to account for the sales discount debits in the balance sheet or income statement is also important as it helps to have an error-free financial report and gives a better understanding of the company’s financial standing.
Furthermore, it is important that all aspects of a company’s finances including how they report sales discounts are in order such that when the need to share these financial records with the bank, investors, or auditor arises, the books will be devoid of errors.
