Difference Between Discount Allowed and Discount Received

Two accounting phrases that are frequently used in commercial operations, especially when sales and purchases are involved, are discount authorised and discount received.

These words refer to monetary incentives that are given as a decrease in the selling price or purchase price of products or services by a seller to a customer (discount authorised) or by a buyer from a supplier (discount received).

Discount Allowed

A vendor may offer a consumer a discount on the selling price in exchange for early payment, larger purchases, or other advantageous conditions. It is shown in the seller's books of accounts as a contra-revenue account and signifies a cost borne by the seller as a part of the sales transaction. Usually, the permitted discount is determined as a percentage of the invoice value or as a predetermined sum decided upon by the buyer and seller.

Reasons permitted for discounts offered

Quick payment: Vendors may provide discounts to clients who pay within a given time frame (for example, monetary discounts for payments received within 30 days).

Bulk purchases: In order to encourage bigger volume sales, sellers may give discounts to clients who buy a lot of goods or services.

Trade discounts: Based on their trade connection, industry standards, or negotiated terms (e.g., discounts for wholesalers, retailers, or preferred customers), sellers may give discounts to customers.

Seasonal promotions: In order to increase sales and draw clients, sellers may provide discounts at particular times of the year or during promotional events.

Allowable accounting treatment of the discount:

When a vendor gives a consumer a discount, the accounting procedure is different based on whether the customer accepts the discount or not:

The seller records the allowable discount as a reduction in revenue and recognises the net amount as sales revenue if the customer takes advantage of the discount and pays within the discount period.

The seller records the whole invoice amount as revenue and separately accounts for the authorised discount as a contra-revenue deduction if the buyer does not take advantage of the discount or if payment is received beyond the discount period.

When a consumer pays within the discount period and a seller offers a 5% cash discount for fast payment, for instance, the seller records the authorised discount as a decrease in revenue and recognises the net amount as sales revenue. In the event that the buyer declines the discount, the seller records the entire invoice amount as revenue and accounts for the permitted reduction as a contra-revenue deduction on its own.

Discount Received

A discount is a sum that a buyer receives from a supplier as a way to thank them for early payment, large purchases, or other advantageous terms. It is included in the buyer's books of accounts as a contra-expense account and denotes a monetary gain that the buyer has received. Similar to the amount of discount permitted, the amount of discount received is usually determined as a fixed sum decided upon by the supplier and the buyer, or as a percentage of the invoice value.

Justifications for the discounts

Quick payment: Vendors may provide buyers with discounts if they pay within a certain time frame (for example, monetary discounts for payments paid within 30 days).

Bulk purchases: In order to encourage bigger volume purchases, suppliers may give discounts to customers who buy a lot of goods or services.

Early settlement: To lower their credit risk and increase cash flow, suppliers may give incentives to customers who pay in advance or settle their accounts early.

Accounting treatment of discount received:

Whether or not the buyer takes advantage of a discount offered by a supplier determines the accounting treatment of the discount.

The buyer records the discount as a reduction in the cost of goods sold (COGS) or as a separate contra-expense account if they take the discount and pay within the discount period.

The buyer records the entire invoice amount as a purchase expense and separately accounts for the discount received as a contra-expense deduction if the discount is not taken advantage of or if payment is made after the discount period.

If the buyer pays within the discount period and the supplier offers a 2% cash discount for early payment, for instance, the buyer records the discount as a reduction in the cost of goods sold (COGS) or as a separate contra-expense account. Should the customer choose not to accept the discount, they will document the entire invoice amount as a purchase expense and deduct the discount as a separate item.

Effect on financial statements: Received discounts directly affect the buyer's profitability and financial performance by lowering the cost of goods sold (COGS) or purchasing expenses shown on the income statement. Usually, they are included in operational income or subtracted from cost of goods sold to determine gross profit. Since discounts mean smaller cash payments for purchases, they may also have an effect on the buyer's cash flow.

How to Calculate Discount allowed

Determining the permitted discount is a basic component of commercial transactions, especially in sales where vendors provide incentives to buyers in order to promote early payment, larger purchases, or other advantageous conditions. Discount authorised, which is usually represented as a percentage of the invoice value or as a defined amount agreed upon between the parties, denotes a reduction in the selling price offered by the seller to the client.

Percentage Discount Method: This method, which involves applying a present percentage rate to the invoice value, is one of the most popular ways to determine the amount of discount that can be applied. The following calculation can be used to determine the allowable discount when applying the percentage discount method:

Where?

The entire sale amount before the discount is applied is known as the invoice value.

The percentage rate of the discount that the seller offers the client is known as the discount rate.

Consider the following scenario: a vendor offers a consumer who pays an invoice for 1,000 on time a 5% cash discount. Using the % discount method, we would apply the following formula to determine the permissible discount:

Allowed Discount: 1,000 × 5% = 50

Consequently, 50 would be the maximum discount that could be applied, and 950 would be the total cost that the consumer would have to pay after the discount.

Fixed Amount Discount Method: Regardless of the invoice value, this method entails providing a fixed dollar amount discount. This strategy is frequently applied in conjunction with special deals or promotions where the vendor sets the predefined amount of the discount. The following calculation can be used to determine the permitted discount when applying the fixed amount discount method:

Where:

The supplier offers the consumer a fixed amount discount, which is a predetermined financial amount.

Let's say a seller gives all purchases over 500 a 100 discount. In the event that a consumer spends 600 on items, a 100 discount is permitted, irrespective of the invoice amount.

Combination Method: Depending on the terms of the sale or certain promotional offers, retailers may occasionally provide customers a combination of set amount and percentage-based discounts. In these circumstances, the invoice value would be discounted by the invoice value multiplied by the percentage and fixed amount discounts to determine the allowable discount. The following calculation can be used to determine the permitted discount when utilising the combination method:

Where:

The wholesale price before the discount is applied is known as the invoice value.

The percentage rate of the discount that the seller offers the consumer is known as the percentage discount rate.

The supplier offers the consumer a fixed amount discount, which is a predetermined financial amount.

Let's say a vendor gives a 10% cash discount on all orders and an additional 50 off purchases exceeding 500. If a consumer makes purchases totalling 700, the permitted discount would be determined as follows:

Permitted Discount: (700 × 10%) + 50 = 70 + 50 = 120

As a result, the maximum reduction of $120 would be permitted, and the total amount due from the client after the discount is deducted would be 580.

Thoughts and Real-World Applications: Sellers should take into account many variables, including pricing tactics, the dynamics of the competition, client preferences, and financial goals, when determining the permitted discount. Discounts can be used to draw in clients, boost revenue, enhance cash flow, and foster client loyalty, but it's crucial to make sure they're sustainable and in line with overarching company objectives.

Additionally, vendors must make sure that clients understand all of the discount terms and conditions, including eligibility requirements, rates, durations, and any restrictions or limitations. By doing this, miscommunications, disagreements, or inconsistencies in the processing of invoices and payments are reduced.

Sellers should also keep a close eye on discount programmes and assess their efficacy over time by examining important performance metrics including sales income, profit margins, client acquisition expenses, and customer retention rates. This enables merchants to modify their discount plans to maximise return on investment and optimise outcomes.

How to Calculate the Discount Received

When a supplier offers a buyer a discount on the purchase price in exchange for early payment, large purchases, or other advantageous circumstances, businesses need to calculate the discount obtained. Accurately calculating the discount received is crucial for businesses to maximise cash flow and efficiently manage expenses.

The amount of the discount obtained is usually stated as a fixed sum that the supplier and the buyer have agreed upon, or as a percentage of the invoice value. The conditions of the purchase agreement and the date of payment determine how much of a discount is received. Here are a few typical techniques for figuring out the discount you received:

The percentage discount technique computes the amount of the discount by multiplying the invoice value by a pre-established percentage rate. This method's calculation is as follows:

Where:

The whole cost of the purchase before the discount is applied is known as the invoice value

The percentage rate of the discount that the supplier offers the buyer is known as the "discount rate."

Let's take an example where a supplier gives a buyer who pays an invoice for 1,000 in full early a 3% discount. Using the percentage discount approach, we would apply the following formula to get the amount of the discount received:

Received Discount = 1,000 × 3% = 30

Consequently, the customer would spend $970 after the discount is applied, with a 30 discount amount earned.

Fixed Amount Discount Method: This type of discount gives a set discount in dollars, independent of the invoice amount. This strategy is frequently applied in conjunction with special offers or promotions where the supplier sets the amount of the discount. This method's formula is easy to understand:

Whereas,

The predetermined monetary amount that the supplier offers the buyer as a discount is called the "Fixed Amount."

Let's say a supplier gives a $50 discount on any order that exceeds $500. Regardless of the invoice value, the buyer would receive a $50 discount if they made purchases totalling 600 in merchandise.

Combination Method: Depending on the details of the purchase agreement or certain promotional offers, suppliers may occasionally provide buyers with a combination of percentage-based and fixed-amount discounts. In these circumstances, the invoice value would be discounted by the invoice value plus the % and fixed amount discounts, respectively, to determine the total discount obtained.

This method's formula is:

Where:

The whole cost of the purchase before the discount is applied is known as the invoice value.

The percentage rate of the discount that the supplier offers the buyer is known as the percentage discount rate.

The predetermined monetary amount that the supplier offers the buyer as a discount is called the "Fixed Amount."

Let's say a supplier gives a 5% discount on all orders and a 25 discount on orders over 500. The following formula would be used to determine the discount obtained if a customer made purchases totalling 700:

Received Discount = (700 × 5%) + 25 = 35 + 25 = 60

Consequently, the buyer would be required to pay $640 after the discount is applied, with the buyer receiving a 60 reduction.

Realistic Aspects to Take into Account

Buyers should take into account some useful criteria to ensure accuracy and efficacy when determining the discount received:

• Terms of the Invoice: Purchasers should carefully read the terms of the purchase agreement, taking note of the discount rate, duration, and terms of payment as well as any additional restrictions or requirements related to the supplier's provided discount.
• Timing of Payment: In order to benefit from the provided discount, buyers should try to make payments within the supplier's designated discount period. In addition to lowering the purchase price, early payment improves cash flow and fortifies the bond between the supplier and the buyer.
• Record-Keeping: In order to keep track of costs, keep an eye on cash flow, and settle accounts payable, buyers must keep precise records of all purchases, discounts obtained, and supplier payments. Buyers should use their purchasing power to bargain with suppliers for advantageous terms, such as volume discounts, rebates, and other concessions that improve the business.
• Compliance: In order to preserve accountability, openness, and accuracy while recording discounts received and other financial transactions, buyers should make sure that they are in compliance with all applicable accounting standards, tax laws, and internal controls.