Discount Allowed vs. Discount Received: A Detailed Guide for Trial Balance

Introduction

When it comes to accounting, understanding the difference between discount allowed and discount received is crucial for maintaining an accurate trial balance. These two types of discounts can significantly impact a company's financial statements and overall profitability.

Discount Allowed

Discount allowed, also known as sales discount, is a reduction in the price of goods or services offered to customers who pay their invoices early. It is an incentive provided by the seller to encourage prompt payment and improve cash flow.

Example

Suppose Company A sells a product for $100. It offers a 2% discount for payments made within 10 days. If a customer pays within the discount period, the net amount they owe becomes $98 ($100 - ($100 x 0.02)).

Discount Received

Discount received, also known as purchase discount, is a reduction in the price of goods or services obtained from suppliers who offer discounts for early payment. It provides an opportunity for buyers to reduce their expenses and improve their profit margins.

Example

Suppose Company B purchases inventory for $5,000. The supplier offers a 3% discount for payments made within 30 days. If Company B pays within the discount period, the net amount they owe becomes $4,850 ($5,000 - ($5,000 x 0.03)).

Recording Discount Allowed and Discount Received in Trial Balance

Both discount allowed and discount received are recorded in the trial balance as follows:

Discount Allowed

• Debit: Sales Discount (contra-revenue account)
• Credit: Accounts Receivable (or specific customer account)

Discount Received

• Debit: Purchases Discounts (income account)
• Credit: Accounts Payable (or specific supplier account)

Impact on Financial Statements

Discount allowed reduces a company's sales revenue, while discount received increases its cost of goods sold. However, it is important to note that the net income remains the same in both cases. This is because the reduction in sales revenue from discount allowed is offset by the increase in other income (Sales Discount), while the reduction in cost of goods sold from discount received is offset by the decrease in other expenses (Purchases Discounts).

Benefits of Discount Allowed and Discount Received

• Improved cash flow: Discount allowed encourages customers to pay early, which improves the seller's cash flow.
• Reduced expenses: Discount received allows buyers to reduce their expenses and increase their profit margins.
• Strengthened supplier relationships: Discount received can build stronger relationships with suppliers as buyers consistently pay their invoices promptly.

Pain Points Associated with Discount Allowed and Discount Received

• Potential lost revenue: Discount allowed can result in reduced sales revenue if customers take advantage of the discount excessively.
• Cash flow management: Discount allowed can strain a company's cash flow if customers consistently pay on the last day of the discount period.
• Timing of discounts: Companies need to carefully consider the timing of discounts to ensure they don't impact their financial statements more than intended.

Key Considerations

• Discount rates: The size of the discount rate offered can significantly impact the company's financial results.
• Discount period: The length of the discount period can affect how much revenue or expense is gained or lost from discounts.
• Customer behavior: Companies should understand their customers' payment patterns to determine if discounts are worthwhile.

Conclusion

Discount allowed and discount received are important accounting concepts that can impact a company's financial position. By understanding the difference between the two and how to record them in the trial balance, businesses can make informed decisions to optimize their cash flow, manage expenses, and maintain accurate financial records.

Additional Resources

• AICPA: Accounting for Discounts
• IRS: Rev. Rul. 71-247
• GAAP: ASC 606

Tables

Table 1: Discount Allowed vs. Discount Received

Table 2: Discount Allowed and Sales Revenue

Table 3: Discount Received and Cost of Goods Sold

Table 4: Pros and Cons of Discount Allowed and Discount Received