Accounting for Purchase Discounts: Net Method vs Gross Method

In the gross method, we record the purchase of merchandise inventory into the purchase account at the original invoice amount. In this section, we illustrate the journal entry for the purchase discounts for both net method vs gross method. In the gross method, we normally record the purchase transaction at a gross amount. This is due to, under the perpetual system, the company records the purchase into the inventory account directly without the purchase account. Hence, it needs to make credit entry to reverse the inventory account when it receives the discount as any amount of the discount will reduce the cost of inventory. The purpose of a business taking purchase discounts is to reduce its costs.

  • This is due to, under the perpetual system, the company records the purchase into the inventory account directly without the purchase account.
  • If the business does not pay within the discount period and does not take the purchase discount it will pay the full invoice amount of 1,500 to the supplier and the discount is ignored.
  • Using the purchase transaction from May 4 and no returns, Hanlon pays the amount owed on May 10.
  • When a company purchases goods on credit, it discusses the repayment terms with the supplier.
  • The purchase was on credit and the return occurred before payment, thus decreasing Accounts Payable.

To comply with the cost principle the company will debit Purchases (or Inventory) for $28,000 and will credit Accounts Payable for $28,000. Accounting for purchase discounts, we can be recorded under either the net method or the gross method. Both methods provide the same result; however, the accounting journal entry is slightly different. Under perpetual inventory system, the company does not have a purchase account nor a purchase discount account. Any transaction related to inventory (e.g. purchase, sale, discount, return, etc.) will be recorded directly into the inventory account.

This is due to under the perpetual inventory system, the balance of the inventory is continuously updated when there is an inventory in or inventory out. Cash discount is the type of discount that we usually receive on the credit purchase when we make the cash payment within a discount period (e.g. within 10 days of the purchase). This type of discount usually has the stated term on which is better virtual cfo or in-house cfo services the purchase invoice, such as 2/10 N/30 or 2/10 net 30, in order to encourage the customers to make payment faster. This journal entry is made when we receive the cash discount after making the cash payment for the credit purchase that we have made within the discount period that is given. Merchandise Inventory-Tablet Computers increases (debit) in the amount of $4,020 (67 × $60).

Usually, suppliers offer a percentage of the total amount as a purchase discount. On top of the discount rate, they will also specify the number of days by which the company must settle the obligation. If the company fails to pay the owed amount by that period, it cannot avail of the purchase discount. A purchase discount reduces the amount owed and repaid to a supplier. This discount is available to companies that acquire goods for credit. Purchase discounts are only applicable if the supplier allows them.

Sale Discount Journal Entry

If the company does not avail of a trade discount, the subsequent journal entry would be to Debit – Accounts Payable and Credit – Cash/Bank. The net amount is not mentioned earlier on in the analysis because it is still not confirmed if the company will be able to pay the dues in time to be able to avail of the cash discount. The incentive to the buyer of purchase discount is that the purchase costs decrease, and the business can save a considerable amount on procurement costs. For example, we are given a 10% discount or $1,000 on the total of $10,000 purchase that we have made. Hence, we need to only pay $9,000 in cash for the purchase upon receiving the goods.

Since it involves paying for those goods earlier, it entails an accounting treatment. In business, it is common that we may receive some percentage of discount on the credit purchase when we make early cash payments. In this case, we need to make the journal entry for discount received on the purchase to record the discount received for the early payment that we have made. Let’s assume that the supplier gives companies that purchase a high volume of goods a trade discount of 30%. If a high volume company purchases $40,000 of goods, its cost will be $28,000 ($40,000 X 70%).

The payment terms are 5/10, n/30, and the invoice is dated May 1. On April 7, CBS purchases 30 desktop computers on credit at a cost of $400 each. Therefore, to set that off, trade discounts are offered which incentivizes buyers of a certain product to pay early, at a cheaper cost.

The company can make the discount received journal entry by debiting the accounts payable and crediting the discount received account and the cash account. Some suppliers offer discounts of 1% or 2% from the sales invoice amount, if the invoice is paid in 10 days instead of the usual 30 days. For instance, let’s assume that a company purchases goods and the supplier’s sales invoice is $28,000 with terms of 1/10, net 30. This means that the company can deduct $280 (1% of $28,000) if it pays the invoice within 10 days. The early payment discount is also referred to as a purchase discount or cash discount.

Discount received example

In this instance the accounts payable balance is cleared by the cash payment and no purchase discount is recorded. The purchase discount is based on the purchase price of the goods and is sometimes referred to as a cash discount on purchases, settlement discount, or discount received. Using the purchase transaction from May 4 and no returns, Hanlon pays the amount owed on May 10. Regardless of whether we have return or allowance, the process is exactly the same under the perpetual inventory system. Both returns and allowances reduce the buyer’s debt to the seller (accounts payable) and decrease the cost of the goods purchased (inventory). On May 21, we paid with cash so we do not have credit terms since it has been paid.

What is a Purchase Discount?

When the company makes the purchase from its suppliers, it may come across the credit term that allows it to receive a discount if it makes cash payment within a certain period after the purchase. Likewise, this purchase discount is also called cash discount and the company needs to properly make journal entry for it when it receives this discount after making payment. Some suppliers may provide a discount when the company makes an early payment (e.g. within 10 days of credit purchase). Likewise, when the company receives the discount by paying the suppliers during the discount period, it needs to make a proper journal entry for the discount received.

Sale discount journal entry

If Music Suppliers, Inc., offers the terms 2/10, n/30 and Music World pays the invoice’s outstanding balance of $900 within ten days, Music World takes an $18 discount. We can make the journal entry for the discount received on purchase by debiting the account payable and crediting the purchase discounts account and the cash account. The journal entry to account for purchase discounts is different between the net method vs the gross method.

Balance Sheet

When making a credit sale, the company may provide a credit term that encourages its customers to pay early by giving the sale discount if the payment is made within a certain period. In this case, if the customer takes the discount by making early payment on the credit purchase, the company needs to account for the sale discount with a proper journal entry. A purchase discount is a reduction in the amount repayable to a supplier.

Cash Discount

This transaction is more fully explained in our purchases on account example. For example, on October 01, 2020, the company ABC Ltd. sells merchandise for $1,500 to one of its customers on the credit term 2/10 net 30. The company properly records the $1,500 of sales revenues and accounts receivable on October 01, 2020.

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