Definition
Discount Allowed refers to a reduction in price given by the seller, often to encourage prompt payment or increase sales volume. On the other hand, Discount Received refers to a reduction in cost that a buyer receives from a seller, typically for paying an invoice earlier than the payment due date.
Both terms are recorded as an account in a company’s financial statements.
Key Takeaways
- Discount Allowed refers to the reduction in price that a seller gives to a buyer, usually as a means to entice the buyer to make a purchase. This is often used as a strategic tool for encouraging quick payment, good business relationships or bulk purchases.
- On the other hand, Discount Received refers to the reduction in price that a buyer gets from a seller. From the perspective of the buyer, this is income because it reduces the amount they have to pay for a product or service.
- Both Discount Allowed and Discount Received have significant impacts on the accounting and finances of businesses. Discount Allowed decreases the revenue generated by sales, while Discount Received can improve the profitability of purchases. Consequently, both terms need to be carefully tracked and recorded in financial statements.
Types of Discounts
There are two primary types of discounts that businesses typically record in their accounts:
- Discounts Allowed
- Discounts Received
Understanding the difference between these two types of discounts is essential for accurate bookkeeping and financial reporting.
Discounts Allowed
Discounts allowed are incentives given to customers who pay their outstanding balances within a specified timeframe. These are also known as cash discounts and are treated as an expense from the business’s perspective. Here’s how to record a discount allowed in your accounts:
Example: Peter’s Pen Shop
Let’s say Peter’s Pen Shop offered a £20 discount to a customer named Gmail for paying within the 30-day credit term. Here’s how to record this transaction:
- Date: 8/11/16 (November 8, 2016)
- Account affected: Discounts Allowed (Debit side)
- Detail: Gmail
- Amount: £20
The corresponding entry in the customer’s account (Gmail) would be:
- Date: 8/11/16
- Account affected: Gmail (Credit side)
- Detail: Discounts Allowed
- Amount: £20
Discounts Received
On the other hand, discounts received are benefits a business gets from its suppliers for paying outstanding amounts within a specified period. Like discounts allowed, these are also considered cash discounts. However, from the business’s perspective, discounts received are treated as revenue. Here’s how to record a discount received:
Example: Peter’s Pen Shop
Suppose Peter’s Pen Shop paid its supplier, PN, before the 30-day credit term and received a £14 discount. Here’s how to record this transaction:
- Date: 13/11/16 (November 13, 2016)
- Account affected: Discounts Received (Credit side)
- Detail: PN
- Amount: £14
The corresponding entry in the supplier’s account (PN) would be:
- Date: 13/11/16
- Account affected: PN (Debit side)
- Detail: Discounts Received
- Amount: £14
Key Differences Between Discounts Allowed and Discounts Received
To help you better understand the distinctions between these two types of discounts, let’s compare their key features:
| Feature | Discounts Allowed | Discounts Received |
|---|---|---|
| Given to | Customers | Business (from suppliers) |
| Accounting treatment | Expense | Revenue |
| Recorded on | Debit side | Credit side |
| Impact on profit | Decreases profit | Increases profit |
Best Practices for Recording Discounts
To ensure accurate financial reporting and maintain clean books, consider these best practices when recording discounts:
- Consistency: Always use the same method for recording discounts throughout your accounting periods.
- Timeliness: Record discounts as soon as they occur to avoid forgetting or misplacing information.
- Double-entry system: Remember to make corresponding entries in both affected accounts.
- Clear documentation: Keep detailed records of all discount transactions, including dates, amounts, and reasons for the discounts.
- Regular reconciliation: Periodically review your discount accounts to ensure they match with customer and supplier records.
The Impact of Discounts on Financial Statements
Understanding how discounts affect your financial statements is crucial for accurate reporting and decision-making. Here’s a brief overview:
Income Statement
- Discounts Allowed: Appear as an expense, reducing your overall profit.
- Discounts Received: Shown as revenue or a reduction in expenses, increasing your profit.
Balance Sheet
- Accounts Receivable: Discounts allowed may reduce the amount owed by customers.
- Accounts Payable: Discounts received may decrease the amount you owe to suppliers.
Importance
Financial terms, such as Discount Allowed and Discount Received, are essential as they play integral roles in business transactions, financial management, and the overall fiscal health of a company.
Discount Allowed pertains to a reduction in price that a seller offers to a buyer, typically as an incentive for bulk purchases or prompt payment, which directly impacts sales revenue and customer relations.
On the other hand, Discount Received relates to the reduction in cost that a company gets from its suppliers, often for early payment or bulk purchases, significantly affecting the cost of goods and profitability.
Both discounts affect the cash flow and financial performance of a business, thus recognizing and managing them appropriately is crucial for effective financial planning and decision-making.
Explanation
Discount Allowed serves as an important tool for many businesses to enhance cash flow, reduce inventory, and promote customer loyalty. Primarily, businesses use it as a part of their pricing strategies to prompt prompt payment or bulk purchases. By offering a reduction on account of immediate cash payment, businesses can ensure faster recovery of funds, thereby lowering the risk of bad debts and improving their cash flow.
This, in turn, could be used for more investments, payables, or any other business needs. Further, allowing discounts on bulk purchases can clear up warehouse space for incoming inventory, favorably impacting the inventory turnover ratio and operational efficiency. On the other hand, Discount Received comes into picture when a business is the buyer and gets a deduction on its payable amount.
This could be part of the supplier’s marketing strategy to attract or retain customers, or as an incentive for quick payment. The primary purpose of receiving discounts is to reduce the cost of purchases, contributing to a business’s overall profitability. Moreover, the timely payment made to avail discounts will also build and maintain a good credit reputation for the business in the marketplace, making its dealings smoother and attracting favorable credit terms in future transactions.
Examples of Discount Allowed and Discount Received
Discount Allowed:
Example 1: A furniture shop might offer a discount allowed to its customers to encourage repeat business or to sell off old inventory. For instance, they might offer a 10% discount on all purchases above $
Example 2: A manufacturing company sells their products usually at a wholesale price. To motivate the distributors to sell their products more, they might offer a 5% discount allowed on the total purchase if the distributors purchase more than a set quantity.
Example 3: An electronics store may offer a ‘student discount’ of 15% to all college students on their laptops. This is also an example of a discount allowed.
Discount Received:
Example 1: A restaurant orders large amounts of meat and dairy products from a local farm. Because the purchase volumes are consistently high, the farm offers the restaurant a 20% discount. This is a discount received scenario from the perspective of the restaurant.
Example 2: An online fashion retailer buys clothes in bulk from manufacturers. Considering the large quantity and long-term relationship, the manufacturer gives a discount of 10% to the retailer.
Example 3: A bookstore might receive a discount from a publishing house due to the large volume of books purchased, for example, a 15% discount if they order more than 100 copies of a book. This provides the bookstore with a discount received.
FAQ: Discount Allowed and Discount Received
What is a discount allowed?
Discount allowed refers to the reduction in price a seller gives to a buyer as an incentive or concession in sales. This could be due to bulk purchasing, prompt payment, or for other reasons the seller sees fit. It is considered a selling expense for the seller.
What is a discount received?
Discount received is the reduction in cost a buyer gets from a supplier. For the buyer, this acts as a saving on the cost side of business transactions. This could be due to bulk buying, early payment, or other situations the buyer benefits from. It is considered as an income for the buyer.
How is discount allowed recorded in accounting books?
In accounting books, a discount allowed is recorded as an expense in the profit and loss account. This means when you give out discounts, it reduces your profit in business because it’s reducing your total income or revenue.
How is discount received recorded in accounting books?
For the buyer, a discount received is recorded as an income. It increases the profit of the business as it reduces the cost needed to buy goods or services. However, it is subject to income tax as it is considered an income.
What are the impacts of discounts allowed and received on business?
The impact of discounts allowed and received can be a double-edged sword. On the selling side, while discounts allowed might lower profit margins, they can also bring in more business and increased sales volume. On the buying side, discounts received reduce the cost of goods, potentially increasing overall profit. However, they could also lead to dependence on such discounts for maintaining profitability.
Related Entrepreneurship Terms
- Cash Discounts: This term relates to discounts that are given to the buyer if they pay within a specific timeframe.
- Trade Discounts: This term refers to the reduction in the retail price of products offered by wholesalers to retailers.
- Volume Discounts: This refers to the price reductions given to buyers when they purchase large quantities of a product or service.
- Prompt Payment Discounts: This relates to the discounts given by a seller to the buyer for making payments quickly, often before the agreed payment time.
- Seasonal Discounts: These are the price reductions offered by sellers during certain seasons or periods to boost their sales.
Sources for More Information
- Investopedia: This website is a powerhouse of finance and investing knowledge where you can find information on almost every finance term including Discount Allowed and Discount Received.
- Accounting Coach: It’s a great resource that offers clear and comprehensive explanations of accounting and financial terms and concepts including Discount Allowed and Discount Received.
- Accounting Tools: This platform presents a mix of free content and professional education in accounting and finance terms. You can look up for Discount Allowed and Discount Received.
- Corporate Finance Institute (CFI): CFI is a leading global provider of online financial modeling and valuation courses. They have a large resource library that explains complex finance terms including Discount Allowed and Discount Received.
