Trade discounts never recorded; cash discounts by the gross method; net sales

Two discounts that are nothing alike

A trade discount is a reduction from a list price given to a class of customer — a school board, a club that buys in volume. It is a way of setting the price, so it is never recorded: the sale is booked at the invoice price after the discount, and no account called Trade Discount exists. A cash discount is an incentive to pay early — written 2/10, n/30: take 2 % off if you pay within 10 days, otherwise the net amount is due in 30. It is recorded, but only if and when the customer takes it, in a contra-revenue account called Sales Discounts. This is the gross method: book the sale at the full invoice amount and record the discount when it is taken.

Worked example — one Bramble Lane order, five entries

2 May — the sale. A canoe club orders gear with a list price of 5,000; as a club it gets a 20 % trade discount; terms 2/10, n/30. Invoice price $5,000\times 80\%=4,000$:

May 2   Accounts Receivable                4,000
            Sales Revenue                            4,000

Not 5,000 — the list price was never the price.

4 May — a return. The club sends back 400 of paddles, saleable. The reduction goes to Sales Returns and Allowances, a contra-revenue account, so that the year's returns are visible rather than buried in Sales Revenue: Dr Sales Returns and Allowances 400 / Cr Accounts Receivable 400. The club now owes 3,600. (Module 8 adds the inventory side: the paddles come back into stock.)

10 May — paid on day 8. Within the discount period, so the club pays $3,600\times 98\%=3,528$ and the 2 %, 72, is a Sales Discount:

May 10  Cash                               3,528
        Sales Discounts                       72
            Accounts Receivable                      3,600

The discount is on 3,600 — what is owed after the return — not on the 4,000 invoiced; taking 80 would give the club a discount on paddles it returned.

Day 25 — a different customer pays 2,200. Past the ten days, so no discount: Dr Cash 2,200 / Cr Accounts Receivable 2,200.

A card sale. A walk-in customer pays 1,500 by credit card; the card company deposits the money the same day less a 2.5 % fee. There is no receivable — the card company has paid — and the fee is an expense of the sale:

Cash                                     1,462.50
Credit Card Expense                         37.50
    Sales Revenue                                  1,500.00

Net sales

The income statement's first line is net sales:

$$\text{Net sales}=\text{Sales revenue}-\text{Sales returns and allowances}-\text{Sales discounts}$$

For the year: gross sales 96,400, returns and allowances 3,100, discounts 1,240 → net sales $96,400-3,100-1,240=92,060$. The two contra accounts are closed with the revenues at year end (L6.4) and, on the statement, a reader sees all three lines — which is the point of keeping them separate: a store whose returns are climbing has a problem that a single net figure would hide.