Resources | Subject Notes | Accounting
Books of prime entry are the first books of entry into which business transactions are recorded. They provide a detailed and chronological record of all financial transactions. Two important types of discounts are commonly encountered: trade discounts and cash discounts. Understanding these discounts and how to account for them is crucial in accounting.
A trade discount is a reduction in the list price of goods or services offered by a seller to a particular class of customers. These customers are usually businesses who intend to resell the goods or use them in their operations. Trade discounts are usually based on the quantity of goods purchased or the nature of the customer.
A cash discount is a reduction in the price offered to customers to encourage them to pay within a specified period. It is offered as an incentive for prompt payment.
The key difference between trade and cash discounts lies in their purpose and timing:
Trade discounts are not usually recorded directly in the business's books of prime entry. Instead, the discounted price (net price) is recorded.
Example: If a manufacturer sells goods with a list price of $100 to a retailer with a 20% trade discount, the retailer pays $80 ($100 - 20% of $100).
The transaction would be recorded in the sales journal or sales ledger as follows:
| Date | Particulars | Debit ($) | Credit ($) |
|---|---|---|---|
| [Date of Sale] | Sales (or Sales to [Retailer Name]) | 80 | |
| Sales Discount | 20 | ||
| Sales Debtors | 80 |
Explanation: The $80 is recorded as sales, and the $20 trade discount is recorded as a contra-sales account (reducing the sales revenue).
Cash discounts are recorded at the time of sale, either in the sales journal or on the customer's account.
Example: A business invoices a customer for $500 with a terms of 2/10, n/30. This means a 2% discount is offered if the customer pays within 10 days, and no discount is offered if payment is made after 10 days but within 30 days.
If the customer pays within 10 days, the following journal entry would be made:
| Date | Particulars | Debit ($) | Credit ($) |
|---|---|---|---|
| [Date of Payment] | Cash (or Bank) | 490 | |
| Sales Debtors | 10 | ||
| Discount Allowed | 10 |
Explanation: The customer pays $490, and the $10 cash discount is recorded as a reduction in the sales debtors account.
If the customer pays after 10 days but within 30 days, no cash discount is allowed, and the full amount of $500 would be recorded.
| Discount Type | Purpose | When Recorded | Effect on Sales Revenue |
|---|---|---|---|
| Trade Discount | To encourage business customers to purchase | At the time of sale, reducing the list price | Reduces sales revenue |
| Cash Discount | To encourage prompt payment | At the time of sale, when payment is made within the discount period | Reduces sales revenue |
Understanding and correctly accounting for trade and cash discounts is essential for accurately recording sales revenue and the amount owed by customers. These discounts are important tools for businesses to manage their sales and cash flow.