How to account for a sales discount
/What is a Sales Discount?
A sales discount is a reduction taken by a customer from the invoiced price of goods or services, in exchange for early payment to the seller. The seller usually states the standard terms under which a sales discount may be taken in the header bar of its invoices. An example of these terms is "2/10 net 30," which means that a customer can take a two percent discount if it pays the invoice within 10 days of the invoice date; alternatively, the customer can pay by the normal payment date, which is 30 days after the invoice date.
A sales discount best practice is to not include the somewhat arcane sales discount terms on an invoice, since they can confuse customers. Instead, list the exact amount of the discount, and the date by which it must be paid. This is much easier for the customer to understand. For example:
Pay $100 by June 30, or Pay $95 by June 10
Accounting for a Sales Discount
When a sales discount is offered to few customers, or if few customers take the discount, then the amount of the discount actually taken is likely to be immaterial. In this case, the seller can simply record the sales discounts as they occur, with a credit to the accounts receivable account for the amount of the discount taken and a debit to the sales discount account. The sales discount account is a contra revenue account, which means that it reduces total revenues.
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The Sales Discount Reserve
If there is a history or expectation of significant sales discounts being taken, then the seller should establish a sales discount reserve at the end of each month 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 amount of discounts that will actually be taken. As discounts are taken, the entry is a credit to the accounts receivable account for the amount of the discount taken and a debit to the sales discount reserve. By taking these steps, the sales discount recognized is accelerated into the same period in which the the associated invoices are recognized, so that all aspects of the sale transaction are recognized at once.
Terms Similar to Sales Discount
The sales discount is also known as a cash discount.