Purchase discount definition
/What is a Purchase Discount?
A purchase discount is a deduction that a payer can take from an invoice amount if payment is made by a certain date. This discount is used when a seller needs to accelerate the inflow of cash. However, the effective interest rate associated with purchase discounts is usually high, so this can be an expensive form of funding.
Characteristics of a Purchase Discount
The key characteristics of a purchase discount are as follows:
Encourages early payment by customers
Is stated as a discount percentage if paid early
Is only offered on the invoice amount, excluding taxes, shipping, and other charges
Failure to adhere to the terms will result in the customer paying the full invoice amount
Accounting for a Purchase Discount
A buyer may elect to separately track the amount of purchase discounts taken in a separate account, in order to evaluate the amount of the associated cost reduction. Alternatively, the discount simply reduces the amount of the expense or asset for which the payment was made. A seller can account for its side of this discount by recording the amount in a contra revenue account, which is paired with and offsets its gross sales account.
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Example of a Purchase Discount
As an example of a purchase discount, a seller offers its customers 2% off the invoiced price if payment is made within 10 days of the invoice date. Otherwise, payment is due in 30 days. This common payment option is contained within the invoicing code "2/10 net 30," which usually appears in the header line of an invoice. As another example of a purchase discount, a supplier offers “1/10 net 60” terms, which means that the customer can take a 1% discount if it pays within 10 days of the invoice date; if not, it can pay the full amount in 60 days from the invoice date.