Cash Discount

Definition

The term cash discount is used to describe a deduction offered by sellers to buyers of goods and services if payment is made within a certain timeframe.  Cash discounts are offered to encourage buyers to pay for the goods or services before the due date specified on the invoice.

Calculation

Price Paid = Invoice Price - (Cash Discount x Invoice Price)

Explanation

While the seller of the goods or services may also refer to a cash discount as a sales discount, buyers may refer to this offer as a purchase discount.  In a business-to-business setting, the invoice rendered by the seller will indicate when the money is due.  For example, the invoice might state:  Payable in 60 days.

Companies will offer cash discounts to buyers to lower accounts receivable, reduce days sales outstanding (DSO), and speed up the cash conversion cycle.  In doing so, the company makes better use of its cash assets. Sellers would record these discounts on the income statement as a contra-revenue account (Sales Discounts).

Cash discounts are oftentimes communicated on invoices, and usually take the following form:

5/14, Net 60

The above would be translated as:  5% discount if paid within 14 days, the net amount is due in 60 days.

Gross Method

Cash discounts are accounted for by companies using either the gross or net methods.  Under the gross method, the sale is recorded at its gross value, before the discount offered.  In this example, a credit sale for $100 is made; with the offer of a cash discount of 5% if payment is made in 10 days.

  Debit Credit
Accounts Receivable   $100
Revenues $100  

If payment is made within 10 days, the transaction is recorded as:

  Debit Credit
Cash   $95
Sales Discounts   $5
Accounts Receivable $100  

If the customer does not take advantage of the discount, the transaction is recorded as:

  Debit Credit
Cash   $100
Accounts Receivable $100  

Net Method

Companies using the net method will record the sale at the net amount, assuming the customer will take full advantage of the discount offered:

  Debit Credit
Accounts Receivable   $95
Revenues $95  

If payment is made within 10 days, the transaction is recorded as:

  Debit Credit
Cash   $95
Accounts Receivable $95  

If the customer does not take advantage of the discount, the transaction is recorded as:

  Debit Credit
Cash   $100
Sales Discounts Forfeited $5  
Accounts Receivable $95  

Example

Company A's list price for a widget is $200.  Company XYZ has purchased 10 widgets.  The invoice received from Company A indicates a cash discount of 2/10, Net 30.  Company XYZ plans to take advantage of this offer, and submits payment within 10 days.  The amount paid by Company XYZ would be calculated as:

Quantity Item Unit Price
10 Red widget, with Company XYZ Logo $200
     
  Subtotal $2,000
  Less: Cash Discount (2%) -$40
  Total Due $1,960

Company A uses the gross method, and records the initial transaction as:

  Debit Credit
Accounts Receivable   $2,000
Revenues $2,000  

Since Company XYZ paid in less than 30 days, the transaction was recorded as:

  Debit Credit
Cash   $1,960
Sales Discounts   $40
Accounts Receivable $2,000  

Related Terms

balance sheet, current assets, accounts receivable, notes receivable, receivables, trade discount