Accounting for Sales Discounts: Definition, Example, Classifications, Journal Entries, and more

Sellers offer sales discounts to increase sales revenue. It increases sales but creates a new accounting entry for sales discounts to be recorded in the account books.

Sellers can offer sales discounts in several forms such as cash discounts, trade discounts, invoice discounts, and so on. The accounting entries for these discounts must reflect on the balance sheet as well as the income statement.

Let us analyze some key measurement and recognition methods for sales discounts.

Sales Discounts

Sales discounts refer to the reduced rate on products or services to customers. It is often presented in the form of percentage rate reduction.

Accounting for sales discounts means recording correct financial entries for the discounted sales. As sales discounts reduce sales figures from actual revenue, the reduction must be reflected appropriately in the account books.

Sales discounts can be recorded in several ways. Some customers would subscribe to the discount offers and others would not. Hence, the account books can create a sales discount contra account at the time of issuing the discount offer.

Let us understand the accounting treatment of sales discounts considering different practical scenarios.

Accounting Entries for Sales Discounts – Scenario 1

Suppose a company Sinra Apparels offers seasonal sale discounts to its customers on various products. Assume the discount rate is 10% on different items.

Suppose price tags before sales discount were, Jacket = $ 150, Shirt = $100, Pant = $100.

The store sold 10 pieces of each item at a 10% discount during the month.

Jackets = 10 × 135 = $1,350             Shirts = 10 × 90 = $900              Pants= 10 × 90 = $900

The journal Entry for the Sales account can be recorded as:

DescriptionDebitCredit
Cash$3,150 
Sales Discount Account$350 
Sales Account $3,500

As you can see the total sales account reflects the sales amount without a discount. We have created a new contra account for sales discount that reduces the cash received by 10% in this case.

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The income statement of Sinra Apparels will also reflect the change.

Gross Sales                                                              = $3,500

Less: Sales Discounts at 10%                          = ($350)

Net Sales                                                                   = $3,150

Explanation

Sinra Apparels can apply the same method across multiple products and multiple discounts. For instance, it may not offer a flat 10% discount on all items. The journal entry for all discount amounts would be shown cumulatively in the “sales discount account”.

The total sales offered on different items will reduce cash. The journal entry for the gross sales will show a cumulative sales figure before discounts. The effect of all discounts combine will be shown as a new line item on the income statement as well.

Accounting Entries for Sales Discounts – Scenario 2 simple examples

Suppose Sinra plc is a wholesale dealer. The company management has decided to offer a 5% sales discount on its currently outstanding invoices to accelerate cash receivables.

One of Sinra PLC’s customers, ABC PLC subscribes to the offer and pays at a discounted rate.

Invoice amount before sales for ABC PLC = $30,000

Sales Discount at 5%                                          = $1,500

The journal for Sinra PLC account books will be:

DescriptionDebitCredit
Cash$28,500 
Sales Discount Account$1,500 
Accounts Receivable $30,000

Similarly, Sinra PLC will adjust the sales discounts in its income statement through a new line item as well.

Gross Sales                                                              = $30,000

Less: Sales Discounts at 10%                          = ($1,500)

Net Sales                                                                 = $28,500

Sales Discounts Across Multiple Invoicing Periods accounting tools and 2 discounts

Companies can offer sales discounts to their retail customers as well as their suppliers. However, all of them may not subscribe immediately. There can be scenarios when sales discounts offered in one month can be subscribed to by customers in the next month.

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In such scenarios, it will be wise for a company to create a contra allowance account for sales discounts immediately. The company can then adjust for actual sales discounts subscribed by clients and cash received.

Let us continue with our example above for a 5% discount to Sinra PLC clients.

The journal entry that Sinra PLC should create immediately:

DescriptionDebitCredit
Sales Discount Account$1,500 
Allowance for Sales Discount $1,500

When the customer makes a payment at a discounted price, Sinra PLC can make a journal entry as below:

DescriptionDebitCredit
Cash$28,500 
Allowance for Sales Discount Account$1,500 
Accounts Receivable $30,000

Similarly, we can consider multiple discount scenarios as well. The company can accumulate all discounts offered to different clients at different rates. The monthly statements will reflect the cumulative figures of allowance for sales discounts on outstanding invoices and the cash received through discounts.

Journal Entries for Sales Discounts

Since companies do not know when exactly customers will avail of their discount offer, they can create a contra account for discounts at the time of issuance.

The journal entry for the sales account when sales occur can be:

DescriptionDebitCredit
Accounts Receivable AccountXXX 
Sales Account XXX

After that, the company can create a sales discount account as well:

DescriptionDebitCredit
Cash AccountXXX 
Sales Discount AccountXXX 
Accounts Receivable Account XXX

The sales discount account will reduce cash by the discount percentage on all invoices. When customers avail of the discount, the accounts receivable gets credited to reflect the change fully on the balance sheet.

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Sales Discounts on Income Statement

Similarly, a company can create income statement entries for the sales account at the time of issuing discounts.

Gross Sales                                                              = XXX

Less: Sales Discounts                                         = (XXX)

Net Sales                                                                   = XXX

The accounting treatment of sales discounts in an income statement is a simple one-line addition. The company will add a new line item after gross sales for the sales discount amount.

As a result, the net sales will reduce by the sales discount amount. The income statement will show the cumulative discount amount for the accounting period.

Types of Sales Discounts

A company can offer different types of sales discounts that can affect the sales figures. These discounts can be offered to retail customers or corporate clients as well.

  • Contract discounts
  • Trade discounts
  • Invoice discounts
  • Retail discounts
    • Product discounts
    • Reduced price discounts
    • Volume discounts
    • Seasonal discounts

The accounting treatment for all discount types will be the same. The company will first translate the discount percentage to a dollar amount. It will then adjust the journal entry for sales discount and accounts receivable accounts.

The cumulative sales discount amounts on all types of discounts will then be reflected on the income statement for the accounting period.

Advantages of Using Sales Discounts

Sales discounts can offer some benefits to sellers and buyers:

  • Sellers can increase their sales
  • Sellers can boost business liquidity
  • Customers can get cheaper products

Disadvantages of Sales Discounts

There are some limitations of sales discounts for both parties as well:

  • Discounts reduce the net profit margins for sellers
  • Buyers may have to incur higher interest costs for availing of discounts

Final Thoughts

Sales discounts can boost the liquidity of a business. The accounting treatment for sales discount for the balance sheet can be adjusted by creating a new contra discount account. The income statement will reflect the cumulative sales discount amount through a new line item after gross sales.

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