Chapter # 3

Discounts

Mariha Shan
Discount and types of discount

Discount: Discount is the reduction in the price of goods below the

amount at which those goods would normally be sold to other customer
of supplier.

Types of Discount:
1. Trade discount
2. Settlement discount
Trade discount:
A reduction in the cost of goods purchased or sold , because of the nature of trading transaction normally
for bulk purchase or for regular trading with a particular business.
a) Related to both cash and credit transactions
b) It is calculated on the list price

Example:
List price 1000
Tarde discount 10%
calculate the net amount payable and amount of trade discount.
No entry is made for trade discount in accounting system. Invoice is made after deducting the amount
of trade discount . Trade discount can be on both type of transaction i.e. cash and credit

Settlement Discount:
A reduction in the amount payable to the supplier in return for immediate or very early payment in cash,
rather than purchase on credit.
a) Related to only credit transactions.
b) Settlement discount is calculated on the net amount (list price – trade discount) at the time of
receipt from the receivables.
c) Calculation of cash discount is never shown on the invoice , its terms are mentioned as foot note
(because of it indefinite nature)
Common discount terms used in examination:

2/10 Net 30
Meaning 2% discount is offered if payment is made within 10 days , otherwise net amount is due within
30 days.

Numerator is always the discount percentage, denominator is the maximum period to avail cash
discount and last figure is the maximum credit period allowed.
 EXAMPLE 1

J Co sold goods with a list price of $2,000 on credit to a customer. J Co has a 30-day payment period
and has offered the customer a 3% prompt payment discount if payment is made within 14 days.
Based on past experience, the customer is expected to pay within 14 days and therefore will be
entitled to the 3% discount.
What accounting would be required to deal with this transaction in the following scenarios:

a) The customer pays within the 14-day settlement period as expected.

b) The customer pays after the 14-day settlement period.
Answer:
The initial sale will be recorded at the discounted amount of $1,940 ($2,000 x 97%) because that is the
amount that J Co expects to receive from the customer:
Dr : Receivable $1940
Cr: Revenue $ 1940

If the customer pays within the 14-day settlement period, the accounting entry would be:
Dr : Cash $ 1940
Cr: Receivable $1940
 If the customer pays after the 14-day period, J Co would instead record this as:
Dr: Cash $2000
Cr: Receivable $1940
Cr: Revenue $ 60

If, based on past experience, J Co did not expect the customer to make the payment within 14 days,
then the full $2,000 would have been recorded as revenue in the first instance. If the payment was
made within the 14-day period after all, this would require an adjustment to reduce revenue by $60.
 EXAMPLE 2

J Co sold goods to another customer with a list price of $8,000. Similar

payment terms were offered to that of the customer in Example 1. Based
on past experience, this customer is expected to pay after 14 days and
therefore will not be entitled to the 3% prompt payment discount.
What accounting would be required to deal with this transaction in the
following scenarios:
a) The customer pays after the 14-day settlement period as expected.
b) The customer pays within the 14-day settlement period.
Answer:
The initial sale will be recorded at the full list price because that is the
amount that J Co expects to receive from the customer:
Dr : Receivable $ 8000
Cr: Revenue $8000
If, as expected, the customer pays after the 14-day period, J Co would
record this as:
Dr: Cash $ 8000
Cr : Receivable $8000
If, however, the customer unexpectedly pays within the 14-day settlement period then part of the initial revenue
recognised must be reversed and the accounting entry would instead be

Dr : Cash $7760
Dr : Revenue $ 240
Cr Receivable $ 8000

An element of judgement is required over whether an entity is likely to take advantage of the prompt payment
discount and, therefore, how much revenue should initially be recognised. This will have an impact on entities’
gross profit margins and there should be appropriate evidence to support judgements made.