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?

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

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).

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.

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.

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.

Here, the buyer records the full gross amount of the cash discount:

In this example, the input tax is not taken into account. A second adjustment record is therefore required:

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.

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.

Here, the supplier records the full gross amount, as shown below:

In this case, the input tax is also not taken into account. Hence, a second adjustment record is required once again:

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.

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.

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:

Please note the legal disclaimer relating to this article.