Accounting: The Language of Business (Part 31)

It's really amazing that in the age of unbelief, as a smart man called it, there isn't even more fraud. After all, with no God, there's no one to ever call you to account, and no accounting at all if you can get away with it.

Ben Stein

Accounting for Merchandising Businesses

(Part D)

by

Charles Lamson

Sales Discounts

The terms of a sale are normally indicated on the invoice or bill that the seller sends to the buyer. An example of a sales invoice for NetSolutions is shown in Exhibit 6.

EXHIBIT 6 Invoice

The terms for when payments for merchandise are to be made, agreed on by the buyer and the seller, are called the credit terms. If payment is required on delivery, the terms are cash or net cash. Otherwise, the buyer is allowed an amount of time, known as the credit period, in which to pay.

The credit period usually begins with the date of the sale as shown on the invoice. If payment is due within a stated number of days after the date of the invoice, such as 30 days, the terms are net 30 days. These terms may be written as n/30. If payment is due by the end of the month in which the sale was made, the terms are written as n/com.

As a means of encouraging the buyer to pay before the end of the credit period, the seller may offer a discount. For example, a seller may offer a 2% discount if the buyer pays within 10 days of the invoice date. If the buyer does not take the discount, the total amount is due within 30 days. These terms are expressed as 2/10, n/30 and are read as 2% discount if paid within 10 days, net amount due within 30 days. The credit terms of 2/10, n/30 are summarized in Exhibit 7, using the information from the invoice in Exhibit 6.

EXHIBIT 7 Credit Terms

Discounts taken by the buyer for early payment are recorded as sales discounts by the seller. Since managers may want to know the amount of the sales discounts for a period, the seller normally records the sales discounts in a separate account. The sales discounts account is a contra (or offsetting) account to Sales. To illustrate, assume that cash is received within the discount period (10 days) from the credit sale of $1,500, shown on the invoice in Exhibit 6. NetSolutions would record the receipt of the cash as follows:

Sales Returns and Allowances

The merchandise sold may be returned to the seller (sales return). In addition, because of defects or for other reasons, the seller may reduce the initial price at which the goods were sold (sales allowance). If the return or allowance is for a sale on account, the seller usually issues the buyer a credit memorandum. This memorandum shows the amount of and the reason for the sellers credit to an account receivable. A credit memorandum issued by NetSolutions is illustrated in Exhibit 8.

EXHIBIT 8 Credit Memorandum

Like sales discounts, sales returns and allowances reduce sales revenue. They also result in additional shipping and other expenses. Since managers often want to know the amount of returns and allowances for a period, the seller records sales returns and allowances in a separate account. Sales returns and allowances is a contra (or offsetting) account to sales.

The seller debits Sales Returns and Allowances for the amount of the return or allowance. If the original sale was on account, the seller credits Accounts Receivable. Since the merchandise inventory is kept up to date in a perpetual system, the seller adds the cost of the returned merchandise to the merchandise inventory account. The seller must also credit the cost of returned merchandise to the cost of merchandise sold account, since this account was debited when the original sale was recorded. To illustrate, assume that the cost of the merchandise returned in Exhibit 8 was $140. NetSolutions records the credit memo in Exhibit 8 as follows:

What if the buyer pays for the merchandise and the merchandise is later returned? In this case, the seller may issue a credit and apply it against other accounts receivable owed by the buyer, or the cash may be refunded. If the credit is applied against the buyer's other receivables, the seller records entries similar to those preceeding. If cash is refunded for merchandise returned or for an allowance, the seller debits Sales Returns and Allowances and credits Cash.

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 239-242*

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