Trade Discounts

Product catalogs often provide a "list price" for an item. Oftentimes those list prices bear little relation to the actual selling price. A merchant may offer customers a trade discount that involves a reduction from the catalog or list price. Ultimately, the purchaser is responsible for the invoice price, that is, the list price less the applicable trade discount. Trade discounts are not entered in the accounting records. They are not considered to be a part of the sale because the exchange agreement was based on the reduced price level. Remember the general rule: sales are recorded when an exchange takes place, based on the exchange price. Therefore, the amount recorded as a sale is the invoice price. The entries above (for the $4,000 sale) would still be appropriate if the list price was $5,000, subject to a 20% trade discount.

Credit Cards

In the retail trade, merchants often issue credit cards. Why? Because they induce people to spend, and interest charges that may be assessed can themselves provide a generous source of additional profit. However, these company issued cards introduce many added costs: customers that don't pay (known as bad debts), maintenance of a credit department, periodic billings, and so forth. To avoid the latter, many merchants accept other forms of credit cards like American Express, Master Card, and so forth. When a merchant accepts these cards, they are usually paid instantly by the credit card company (net of a service charge that is negotiated in the general range of 1% to 3% of the sale). The subsequent billing and collection is handled by the credit card company. Many merchants will record the full amount of the sale as revenue, and then recognize an offsetting expense for the amount charged by the credit card companies.

Cash Discounts

Merchants often sell to other businesses. For example, assume that Barber Shop Supply sells equipment to various barber shops on open account (i.e., a standing agreement to extend credit for purchases). In these settings, the seller would like to be paid promptly after billing, and may encourage prompt payment by offering a cash discount (also known as a sales discount).

There is a catch, though. To receive the cash discount, the buyer must pay the invoice promptly. The amount of time one has available to pay is expressed in a unique manner, such as 2/10, n/30 - these terms mean that a 2% discount is available if the invoice is paid within 10 days, otherwise, the net amount is expected to be paid within 30 days. Assume that Barber Shop Supply sold goods for $1,000, subject to terms of 2/10, n/ 30. The following entry would be recorded at the time of sale:

The invoice that would be issued by Barber Shop Supply is illustrated on the next page. Take special note of the invoice date, terms, and invoice amount.

If Hair port landing pays the invoice in time to receive the discount, the check below for $980 would be received by Barber Shop Supply, and recorded via the following entry. This entry reflects that the customer took advantage of the discount terms by paying within the 10-day window. Notice that the entry reduces accounts receivable for the full invoice amount because the payment satisfied the total obligation. The discount is recognized in a special Sales Discount account. The discount account would be reported in like manner to the Sales Returns and Allowance account presented earlier in this chapter.

If the customer pays too late to get the discount, then the payment received should be for the full invoice amount, and it would be recorded as follows:

Having looked at several of the important and unique issues for recognizing sales transactions of merchandising businesses, it is now time to turn to the accounting for purchasing activities.