Sales discounts

Sales discounts are cash reductions offered to the customer in an

attempt to ensure that they make prompt payments on their
trade accounts. Sales discounts appear as a reduction in the price for a
particular product.
It is offered to the purchaser if they are able to pay off their credit
purchases in a given period.
An example of a sales discount is when a buyer is entitled to
a 1% discount in exchange for paying within 10 days of the invoice date,
rather than the normal 30 days. This is often stated in the invoice as
"1% 10/Net 30" terms.
Another example is "2% 10/Net 30" terms, which means that a buyer
will enjoy a 2% discount if he settles his balance within 10 days of the
invoice date, or pays the full price in 30 days.
Sales discounts only appear as expenses on the income statement, and
not on the balance sheet. Another term for sales discounts is cash
discounts or early payment discounts.
Accounting Treatment for Sales Discounts
Sales discounts are not technically expenses because they actually
reduce the price of a product.
However, these cash reductions offered to customers have an effect on
a company's financial statements so they must be recorded as a
reduction in revenue under the line item called accounts receivable.
Sales discounts do not reduce any assets or liabilities, only revenue
which reduces net income. The sales discounts account is classified as a
contra revenue account.
It is a reduction of gross sales which correspondingly causes a decrease
in the net sales figure. Sales discount will be reflected in the income
statement this way:
Effects of Sales Discounts on Businesses
Sales discounts may induce a company to encourage prompt payment
from its customers. The sooner a company receives cash after providing
a good or service, the better off it is financially.
Sales discounts allow companies to receive more money earlier at the
expense of revenue which will be recognized in the future as time goes
on.
However, if a company has not been prompt in paying their suppliers,
then offering sales discounts can help alleviate the situation because
now both parties are being treated equally. It is beneficial for both
parties to pay as soon as possible.
Sales discounts also have a secondary effect on companies because it
allows them to "control" their accounts receivable balances by knowing
when they will receive payment.
Final Thoughts
Sales Discounts are a useful tool for companies to encourage customers
to settle their credit purchases now rather than later. Sales discounts
are not expenses so they do not have any effect on assets or liabilities,
only revenue that will reduce net income.
However, even though sales discounts are considered a type of
promotion to encourage the early collection of debts from customers,
companies should still be cautious in implementing it because in a way
it decreases their revenue and net income.
Thus, companies should ascertain whether or not offering sales
discounts will truly benefit them in the long run.