It’s not unusual for the list price of the goods available for sale or the total amount of the invoice to not be what the customer eventually ends up paying. The amount the customer pays may be subject to a trade or cash discount.
Trade: With a trade discount, the company sells its products for less than list price. The easiest way to explain this is to imagine a catalog of goods a manufacturer has for sale. In this catalog, a certain model number of washing machine lists for $350.
A buyer at a chain of appliance stores puts in an order for 500 washing machines. The manufacturer offers a trade discount of 20 percent, reducing the price per washer by $70 ($350 x 20%). The manufacturer books the revenue and accounts receivable at $140,000 [$280 (350 – $70) x 500].
Sales discounts: If the customer accelerates payment, it’s allowed a certain amount of discount. You’re probably familiar with this basic financial accounting issue.
Just to recap, companies usually present their cash discounts in a manner such as 2/10, n/30, which means the customer takes a 2 percent discount if paying within ten days; otherwise, the entire amount in due in 30 days. Using the $140,000 accounts receivable amount from earlier, if the washing machine customer is given terms of 2/10, net 30, the discount for early payment is $2,800 ($140,000 x .02).
If a company is using the net method and the customer doesn’t end up taking the discount, the amount of discount passed up gets credited (added to) the Sales Discount Forfeited account.