Recording cash discounts
Cash discounts are discounts granted to customers by service suppliers. Since entrepreneurs want their customers to settle invoiced amounts as quickly as possible, cash discounts are applied to motivate customers to pay due amounts within a certain time by offering a discount of x percent on the total amount. How does this accounting procedure actually work? Which records are used, and what is to be considered?
- What to keep in mind when recording cash accounts
- How to record cash discounts?
- Examples of accounting records with cash discounts
- Two methods for recording cash discounts
- Records from the buyer’s perspective
- Records from the supplier’s perspective
- Overview of advantages and disadvantages of net and gross postings
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What to keep in mind when recording cash accounts
Cash discounts are the bread and butter of both suppliers and buyers. It is considered a win-win situation, whereby the supplying company receives the desired amount quicker, while buyers save a few pounds without much effort. However, there are a few things to consider when recording cash discounts:
- When a cash discount is granted, it stands for a deduction on the total price
- Cash discounts reduce the cost of purchase, which is particularly noticeable with high-priced goods or services
- Input tax is also affected and subsequently reduced
How to record cash discounts?
In previous articles, we have already seen how to calculate cash discounts. However, it is worth reminding that cash discounts always refer back to the gross amount of each invoice. What is therefore reduced is not only the net amount, but also the input tax. The invoice follows the following formula:
Cash discount = gross amount x discount rate
Total due = gross amount less cash discount
Although cash discounts are cost reductions falling into the same category as cash rewards and rebates, accountants usually record them differently. Since they are claimed and granted after the invoicing procedure, they must also be comprehensibly recorded by accountants on a balance sheet (as opposed to rebates, for instance).
When recording cash discounts, it suffices to follow UK’s standard chart of accounts principles.
Examples of accounting records with cash discounts
What does a classic cash discount accounting entry actually look like? To some, this concept seems a little too abstract. However, it must be noted that a cash discount is both a price reduction and a partial cancellation of respective accounting records. If a buyer pays an amount which includes a discount, then this is most noticeable in both the buyer’s and supplier’s corresponding accounting records. In both cases, cash discount records are seen as offsetting entries.
A new couch for the office
Let’s assume that you buy a new couch for £2,000 for your office, for which you receive a 3% discount under the condition that the invoiced total is settled within 14 days.
Calculating gross cash discount
3% of £2,000 = £60
Here, the gross cash discount amounts to £60, after the deduction of which your supplier receives £1,940 instead of the original sum of £2,000.
Calculating net cash discount
Changes in delivery costs automatically affect the VAT amounts, which are to be paid both by the supplier and the buyer (as they are included in the gross price). To work out the net cash discount, we subtract VAT from the total gross amount. Assuming that the VAT rate stands at 19%, the calculation is as follows:
£60 divided by 1,19 = £50,42 of net cash discount
The cash discount of £60 therefore includes a VAT of £9,58.
Two methods for recording cash discounts
If you are a buyer who avails of cash discounts when paying for goods or services, both you and your supplier must record cash discount amounts as reductions on the original invoiced amount. This can be done either with a gross or net posting. Below are some examples of various accounting records.
Records from the buyer’s perspective
Gross postings
Here, the buyer records the full gross amount of the cash discount:
Liabilities | £2,000 | |
Less cash discount received | £60 | |
Amount remaining | £1,940 |
In this example, the input tax is not taken into account. A second adjustment record is therefore required:
Cash discount received | £9,58 | |
Input tax amount | £9,58 |
Net postings
In this method, the net cash discount amount and its corresponding input tax are recorded synchronously. In practice, this represents the most common method for recording cash discounts.
Liabilities | £2,000 | |
Less net cash discount received | £50,42 | |
Less input tax | £9,58 | |
Amount due | £1,940 |
Net cash discounts are therefore directly inserted in the books and not recorded first as gross cash discounts under ‘cash discount received’, as is the case with gross postings.
Records from the supplier’s perspective
Gross posting
Here, the supplier records the full gross amount, as shown below:
Bank | £1,940 | |
Granted cash discount | £60 | |
Receivables | £2,000 |
In this case, the input tax is also not taken into account. Hence, a second adjustment record is required once again:
VAT | £9,58 | |
Granted cash discounts | £9,58 |
Net posting
Once again, the net cash discount amount and its corresponding input tax are recorded synchronously. This represents the most commonly used method when recording cash discounts.
Bank | £1,940 | |
Granted cash discount | £50,42 | |
VAT | £9,58 | |
Receivables | £2,000 |
Net cash discounts are therefore once again directly recorded in the books and not recorded first as gross cash discounts under ‘cash discount received’, as in the case of gross postings.
Overview of advantages and disadvantages of net and gross postings
In terms of accounting principles, both the net and gross posting methods are deemed valid. It is solely your personal preference which is going to have a decisive say in the final choice between the two. Below are some of their most common advantages and disadvantages:
Posting type | Advantage | Disadvantage |
Gross | Clear layout since the tax adjustment is recorded separately | Two records are needed – hence why gross posting requires more accounting effort |
Net | Only one record is needed, hence why this is the most commonly used method | Layout is less clear since the gross cash discount amounts are not as clearly defined and not recorded on a separate account |
Please note the legal disclaimer relating to this article.
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