The first section of an income statement reports a company’s sales revenue, purchase discounts, sales returns and cost of goods sold. This information directly affects a company’s gross and operating profit. A purchase discount is a small percentage discount a company offers to a buyer to induce early payment of goods sold on account.
Companies make credit sales to increase sales revenue without requiring immediate cash payment. This allows more consumers to purchase goods using the seller as a short-term financing option. When the seller sends out a bill for goods sold on account, it may include a purchase discount listed as "1/10 Net 30." This means a buyer can earn a 10 percent discount by paying the bill within 10 days of receipt of the invoice.
Accountants must make specific journal entries to record purchase discounts. When a buyer pays the bill within the discount period, accountants debit cash and credit accounts receivable. Another part of the entry debits purchase discounts and credits accounts receivable for the discount taken by the buyer. If the buyer does not take the discount, then accountants do not make the second entry. They simply debit cash and credit accounts receivable for the full amount.
Purchase discounts is a contra revenue account. Revenue accounts carry a natural credit balance; purchase discounts has a debit balance as a contra account. On the income statement, purchase discounts goes just below the sales revenue account. The difference between the two results in net sales revenue. Accounts receivable is a current asset included on the company’s balance sheet.
When offering purchase discounts, companies must ensure they do not offer discounts that severely reduce their sales revenue. Too many discounts or extremely high discount percentages can reduce the company’s revenue and profit. A review of the company’s customers may also be necessary to determine which purchasers receive the discount. Offering the discount to select customers can improve the relationship between the company and those customers.
- "Fundamental Financial Accounting Concepts"; Thomas P. Edmonds, et al.; 2011