Discounts – SS1 Financial Accounting Lesson Note (First Term)

A discount is an allowance given by a supplier or seller to a buyer, either as a deduction from the price or as a percentage.

Behavioural objectives

1. Define discount.
2. Name the two types of discount.
3. Distinguish between discount allowed and discount received.
4. Explain how cash discounts are recorded in the cash book.
5. Calculate trade discount, net selling price and cash discount.
6. State reasons for granting discounts.

What are the types of discounts?

There are two types of discount: cash discount and trade discount.

Cash discount

Cash discount is an allowance given in return for prompt payment.

• When it is given: the buyer pays immediately or within a stated period, for instance 7 to 30 days.
• Who gives it: a business or supplier that wants its money early.
• Effect: the buyer pays less than the amount on the invoice.
• Kinds: discount allowed and discount received, explained below.

Discount allowed

Discount allowed is a reduction in the cash to be paid by a debtor for prompt payment.

• Who gives it: the seller, to a customer who owes money (a debtor).
• Cash book entry: the discount allowed column on the debit side.
• Effect on the seller: an expense, because the seller receives less cash.

Discount received

Discount received is the discount a trader gets from a creditor for paying the account promptly.

• Who gets it: the buyer, who owes a supplier (a creditor).
• Cash book entry: the discount received column on the credit side.
• Effect on the buyer: a gain, because the buyer pays less cash.

Trade discount

Trade discount is a reduction from the list price given by a manufacturer or supplier to a trader.

• Who gives it: manufacturers or suppliers, as a deduction from catalogue prices.
• Catalogue or list price: the gross selling price.
• Net selling price: the price left after the trade discount is deducted from the gross price.
• Invoice: the trade discount is shown on the invoice, and the goods are recorded at the net price.
• Recording: trade discount is not entered in the cash book.

What is the difference between discount allowed and discount received?

Discount allowed is given by a business to its debtors. Discount received is given to a business by its creditors.

How do cash discounts appear in the cash book?

Cash discounts are entered in extra columns on each side of the cash book.

• Cash received from a debtor: the cash and the discount allowed are both entered on the debit side.
• Cash paid to a creditor: the cash and the discount received are both entered on the credit side.
• Discount columns: they are memorandum columns, so they are totalled but not balanced like the cash column.
• Posting the totals: the total of discount allowed is debited to the discount allowed account. The total of discount received is credited to the discount received account.

Worked entries

• Debtor pays early: a debtor owes N20,000 and pays N19,000. Debit cash N19,000 and discount allowed N1,000. Credit the debtor’s account N20,000.
• Business pays creditor early: a business owes N30,000 and pays N28,500. Debit the creditor’s account N30,000. Credit cash N28,500 and discount received N1,500.

What is the difference between cash discount and trade discount?

Cash discount rewards early payment. Trade discount reduces the list price for a trader or bulk buyer.

How do you calculate discounts?

A discount is found by taking a percentage of the amount, then subtracting it from that amount.

• Discount: rate % × amount.
• Net selling price: list price less trade discount.
• Cash to be paid: amount owed less cash discount.

Trade discount (worked example)

1. Write the list price: goods listed at N50,000.
2. Find the discount: 10% of N50,000 = N5,000.
3. Subtract it from the list price: N50,000 less N5,000 = N45,000.
4. The net selling price is N45,000.

Cash discount (worked example)

1. Write the amount owed: a debtor owes N20,000.
2. Find the discount: 5% of N20,000 = N1,000, for payment within 14 days.
3. Subtract it from the debt: N20,000 less N1,000 = N19,000.
4. The debtor pays N19,000. The seller enters N1,000 as discount allowed.

Why are discounts granted?

Sellers grant discounts to increase sales and to receive their money early.

1. Bulk purchases: to encourage customers to buy large quantities.
2. Prompt payment: to make customers pay early.
3. New customers: to attract new customers.
4. Bad debts: to reduce the risk of debts that are never paid.
5. Profit margin: to allow the buyer or retailer to make a profit when reselling.

Evaluation

1. What is a discount?
2. State the difference between a cash discount and a trade discount.
3. On which side of the cash book is discount allowed entered? Which side takes discount received?
4. What is the gross selling price, and how do you get the net selling price from it?
5. State three reasons for granting discounts.

Assignment

1. State four features of each of the following:
   1. Trade discounts
   2. Cash discounts
2. List five reasons why a trader will grant a discount to his customers.