Published in: Accounting

What type of Account is Sales Discounts?

Author Obotu Agape Oguche

Published on: October 6, 2022

What type of account is sales discounts on financial statements? A sales discount is recorded in a separate account from sales revenue in accounting records and is reported on the income statement. There are two main types of discounts in accounting that might occur in businesses such as trade discounts and sales discounts. A sales discount takes place when a seller offers a reduction in the sales price to a customer as an incentive to pay an invoice within a certain time.

A trade discount, on the other hand, takes place when the seller reduces the sales price for a wholesale customer, such as on bulk orders. This type of discount unlike the sales discount does not appear in the accounting records or on the financial statements specifically.

In this article, we will discuss what type of account sales discounts is and how it is recorded in the financial statements.

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A typical example of the terms of sales discount is the ‘2/10 net 30’. This term means that a customer can take a two per cent discount if he or she pays the invoice within 10 days of the invoice date or alternatively, the customer can pay the full price of goods or services within 30 days after the invoice date. Another example is the 1/10 net 30, whereby the customer takes a 1% discount in exchange for paying within 10 days of the invoice date or making the full-price payment within 30 days after the invoice date.

Offering a sales discount incentivizes the buyers or customers to pay invoices in a timely manner. When a company’s invoices are settled early, it helps reduces the amount of time that the business is extending credit. This improves cash flow and reduces the risk of bad debt and invoice aging. Hence, companies offering small discounts for a 10-day payment return help to clear accounts quickly. Customers taking advantage of the sales discount tend to reduce the overall revenue figures for the business but encourage early payments as well as reduce bad debt. Moreso, early payments support the liquidity position of the company and reduce outstanding accounts receivable.

Sales discounts are not only beneficial to the company, but it also benefits the buyer too. When a customer takes advantage of an early payment discount, the amount that was supposed to be paid is reduced by a certain percentage. That is the customers buy their goods at slightly lower prices. The disadvantage of this, however, to the seller is that they bear the brunt of lower revenue due to sales discounts. Offering a sales discount is like an extra cost for the seller. Also, the buyer can be disadvantaged if the cost of funds for the early payment is higher than the sales discounts. In this case, the buyer effectively loses money on the transaction.

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That is, a sales discount is a contra-revenue account that takes into account the value of price reductions that are granted to buyers or customers in order to encourage early payments. The sales discounts account is presented on the income statement as a contra-revenue account, that offsets gross sales, which results in a smaller net sales figure.

The sales discount account would appear on the income statement like this:

Contra revenue accounts are presented separately from the gross sales revenue on an income statement to show the discounts, allowances, and returns that reduced the original total value of the sale to the net amount. This is more informative for the users of financial statements rather than when a net balance is reported only. That is, the reader of the income statement will be able to distinguish between the original amount of sales revenue generated, the sales reduction, and the resulting net amount.

However, a company may decide to simply present its net sales in its income statement, rather than breaking out the sales discount and gross sales separately. This is usually common when the amount of sales discount is so small that a separate presentation does not yield any material additional information for the reader of the financial statement.

Nonetheless, it is usually advisable to use a revenue account and a contra-revenue account when recording sales. The revenue account reports the value of an original sale while the contra revenue account reports the details of any discounts, returns and allowance that reduces the value of the original sale. A contra-revenue account allows the company to see the original amount sold and also see the items that reduced the sales to the net sales amount. Sales Discounts as well as Sales Returns and Allowances are all examples of contra-revenue accounts.

The table below shows the sales revenue accounts as well as the contra revenue accounts and their natural balance:

As seen from the table above, all contra-revenue accounts offset the sales revenue accounts. Therefore, the net revenue balance on the income statement is calculated as gross revenue sales minus all contra revenue sales (discounts, returns and allowance). This means that:

Contra revenue sales = Gross revenue sales – Net revenue sales

Discounts on sales are recorded in a contra-revenue account named Sales Discounts. Therefore, its debit balance will be one of the deductions from sales (gross sales) in order to report the amount of net sales. Sales discounts as a contra-revenue account are expected to have a debit balance rather than the usual credit balance of revenue. This means that the expected balance of sales discount is contrary to, or opposite of, the usual credit balance in a revenue account.

Recording sales discounts

When a few customers take a sales discount or a discount is offered to a few customers, the amount of the sales discount taken is likely to be immaterial. Therefore, in such an instance, the seller can simply record the sales discount as they occur with a credit to the accounts receivable account for the amount of discount taken and a debit to the sales discount account. The sales discount as a contra-revenue account will reduce the total revenues.

Furthermore, if there is a history or expectation of significant sales discounts being taken, then at the end of each month, the seller should establish a sales discount reserve with a debit to the sales discount contra account and a credit to the sales discount reserve. This reserve is based on an estimate of the likely number of discounts that will be taken.

As the sales discounts are taken, the entry is recorded as a credit to the accounts receivable account for the amount of the discount taken and a debit to the sales discount reserve. By doing these steps, the sales discount recognized is accelerated into the same period in which the associated invoices are recognized, so that all aspects of the sale transaction are recognized at once.

Journal entry for sales discounts

When goods are sold to a customer on credit, according to the Association of Chartered Certified Accountants, the first thing is to debit the accounts receivable account in a journal entry by the full invoice amount of the sale before a cash discount. Then, credit the sales revenue account by the same amount in the same journal entry. The accounts receivable as an asset account increase by the debit entry and the sales revenue unlike an asset account increases by a credit entry.

Take, for instance, the business sold $100 worth of products to a customer who will pay the invoice at a later date. A debit of $100 will be made to accounts receivable and a credit of $100 will be made to the sales revenue account.

When the customer eventually makes an early payment for the goods bought and takes advantage of the sales discount, the amount of the sales discount is subtracted from the full invoice amount to determine the amount of cash that the company receives as the customer pays the invoice. If, for instance, the customer received a 1 per cent discount on the $100 for paying early. It means that the customer pays $99 in cash (i.e $1 is subtracted from $100).

The cash account is debited in a new journal entry by the amount of $99 cash received from the customer and the sales discount account is debited by the amount of the $1 discount. That is debit cash by $99 and debit sales discounts by $1. The debit entries increase the cash and sales discount accounts. Then, credit the accounts receivable account in the same journal entry with the full invoice of $100 amount. This would remove the invoice amount from accounts receivable.

Furthermore, when reporting the discount, the amount of total sales discounts for an accounting period is reported on a line called ‘Less: Sales Discounts’ below the sales revenue line on the income statement. For instance, if a small business had $300 in discounts during the period, it will be reported as ‘Less: Sales discounts $300.’

The total sales discounts are then subtracted from the gross sales revenue that has been earned in the period before accounting for discounts. The result is reported as ‘Net sales’ below the sales discounts line on the income statement. The net sales amount is the actual revenue that has been earned after accounting for discounts. Take, for instance, a business that had $20,000 in gross revenue during the period. $300 will be subtracted from $20,000 to get $19,700 in net sales. This is reported as ‘Net sales $19,700’ below the sales discounts line.

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Sales discounts as a contra revenue account

SO ‘what type of account is sales discounts’? A sales discount is a type of contra account that offsets revenue. Contra accounts are usually reported on the same financial statement as the associated account. This is why sales discount is reported on a line called ‘Less: Sales Discounts’ below the sales revenue line on the income statement.

In a general ledger, contra accounts are used to reduce the value of the related account when the two are netted together. Hence, the natural balance of a contra account would always be contrary to the associated account. This means that, if the natural balance recorded for the related account is a debit, the contra account will record a credit balance. This is why sales discounts as a contra account have a debit balance since the natural balance for revenue is a credit balance.

There are four main types of contra accounts such as contra asset, contra revenue, contra liability, and contra equity. The contra revenue is a reduction from the gross revenue that a business reports, which results in net revenue. Contra-revenue transactions are reported in one or more contra-revenue accounts, that normally have a debit balance contrary to the credit balance in the typical revenue account. Sales Returns Account, Sales Allowances Account, and Sales Discounts Account are the three commonly used contra revenue accounts.

They appear near the top of the income statement, as a reduction from gross revenue. If the amounts of these contra-revenue accounts are minimal, they may be aggregated for reporting purposes into a single contra-revenue line item. The sales discounts account as a contra revenue account contains the amount of sales discounts given to customers, which is normally a discount given in exchange for early payments.

Contra revenue accounts can also be recorded within the sales account, but this means that it will be buried within the total amount of revenue reported, so that management cannot easily determine the amount of contra revenue. If a company has minimal contra-revenue activity, it is understandable to record these transactions within the revenue account.

Examples of sales discounts as a contra revenue account

Let’s look at some examples of sales discount as a contra revenue account and how it is recorded as a debit contrary to the natural credit balance of revenue.

Example 1

Company XYZ sold merchandise to Company ABC for a total sales price of $90,000. Say, Company ABC is given 30 days to pay the amount and will be granted a 5% discount if it pays within 10 days.

The journal entry to record the merchandise sold on credit would be:

If Company ABC paid for the goods after the discount period has expired, the journal entry to record the payment would be:

Nevertheless, if Company ABC paid within the discount period of 10 days, the journal entry would be:

Therefore, if this transaction were the only invoice issued by Company XYZ during the reporting period, and Company ABC paid within the reporting period, then the revenue section of XYZ’s income statement would look like this:

As seen in the financial statement above, the sales discount as a contra revenue account appears as a $4,500 reduction from the gross revenue of $90,000 that Company XYZ reported, which results in net revenue of $84,500.

Example 2

Company ABC sold some pharmaceutical products on credit to Mr John on the 1st of September, 2020 and the total amount on the invoice was $30,000 which he has to pay on or before the 1st of October 2020. Now, if Mr John makes full payment before 15th Sept 2020, a 5% discount will be given.

Say, Mr John paid the full amount of $30,000 on 10th Sept 2020 and benefited from the discount. The journal entry for this sales discount will be as follows:

As shown in the table above, the discount of $1,500 will be debited from Sales discount A/c, and a debit entry will be made for the remaining $28,500 in Cash A/c. Then, a credit entry will be made for the full amount of $30,000 in Account Receivables A/c. Now, when reporting this on the income statement, the revenue section would look like this:

As seen in the report above, the sales discount as a contra revenue account appears as a $1,500 reduction from the gross revenue of $30,000 that Company ABC reported, which results in net revenue of $28,500.

Example 3

In order to illustrate another example of a sales discount, assume that a manufacturer sells $900 worth of products to its customer and its credit terms are 1/10, n/30.

This term given means that the customer can satisfy the $900 obligation if he pays $891 ($900 – $9 of sales discount) within 10 days. The other alternative is for the customer to pay the full $900 within 30 days.

Now, if the customer pays the $891 within 10 days, the manufacturer will record the transaction as follows:

When reporting this on the income statement, the revenue section would look like this:

As seen in the financial report above, the sales discount as a contra revenue account appears as a $9 reduction from the gross revenue of $900 that the manufacturer reported, which results in net revenue of $891.

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Conclusion

What type of account is sales discounts? A sales discount is a type of contra account that offsets revenue. This means that the expected balance of sales discount is contrary to the usual credit balance in a revenue account. As a contra revenue account, sales discount on the income statement is reported on a line called ‘Less: Sales Discounts’ below the sales revenue line.

They appear near the top of the income statement, as a reduction from gross revenue and are thus recorded in a contra-revenue account named Sales Discounts. Therefore, the debit balance of the sales discount will be one of the deductions from sales (gross sales) in order to report the net sales. Sales discount as a contra revenue account is expected to have a debit balance rather than the usual credit balance of revenue.

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