Cash discount

A customer has been invoiced 100 for goods and takes a 5% cash discount for early settlement.

The original invoice would have been posted to accounts receivable, so the balance before the cash discount settlement on the customers account is 100. A 5% cash discount on 100 is 5, and the amount of cash the customer pays is 95.

A cash discount is a type of sales discount, sometimes called an early settlement discount, and is recorded in the accounting records using two journals. The first journal is to record the cash being received from the customer. The second journal records the cash discount to clear the remaining balance on the customers account.

Journal 1 Entry for Cash Received

The accounting records will show the following bookkeeping entries when the cash is received from the customer after deduction of the cash discount.

Journal 1 Entry for Cash Received
Account Debit Credit
Cash 95
Accounts receivable 95
Total 95 95

Cash Received Bookkeeping Entries Explained

Debit
The cash is received from the customer and increases the cash in the business.

Credit
The amount owed by the customer 100 would have been sitting as a debit on the customers accounts receivable account. The credit above reduces the account balance to the amount of the cash discount 5 .

The Accounting Equation

The Accounting Equation, Assets = Liabilities + Owners Equity means that the total assets of the business are always equal to the total liabilities plus the equity of the business, this is true at any time and applies to each transaction. For this transaction the accounting equation is shown in the following table.

Cash Received Accounting Equation
Assets = Liabilities + Owners Equity
Cash + Accounts receivable = None + None
95 – 95 = 0 + 0

In this case one asset (cash) is increased as the money is deposited in the bank account, and another asset (accounts receivable) is reduced as the money owed by the customer is reduced.

Journal 2 Cash Discount Allowed Entry

The accounting records will show the following bookkeeping entries for the cash discount when the cash discount is posted to clear the remaining balance on the customers account.

Journal 2 Entry for a Cash Discount
Account Debit Credit
Discounts Allowed 5
Accounts receivable 5
Total 5 5

Cash Discount Bookkeeping Entries Explained

Debit
The cash discount given to the customer is an expense for the business and appears on the income statement under the heading the discounts allowed thereby reducing the net sales amount shown.

Credit
The balance of the amount owed by the customer (100 – 95 = 5) would have been sitting as a debit on the accounts receivable account. The credit above clears the amount due from the customer and reduces this balance to zero.

The Accounting Equation

The Accounting Equation, Assets = Liabilities + Owners Equity means that the total assets of the business are always equal to the total liabilities plus the equity of the business, this is true at any time and applies to each transaction. For this transaction the accounting equation is shown in the following table.

Cash Discount Accounting Equation
Assets = Liabilities + Owners Equity
Accounts receivable = None + Discounts allowed
 – 5 = 0 + – 5

In this case an asset (accounts receivable) is reduced as the balance on the account is cleared, the discount allowed is treated as an expense in the income statement, reducing net income, retained earnings and therefore the owners equity in the business.

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