What should be the entry when goods are purchased at a discount?

Definition of Goods Purchased at a Discount

There are two common types of discounts for companies buying goods to resell:

• Trade discount
• Early payment discount

Examples of Entries for Goods Purchased at a Discount

Trade discount. Some suppliers have catalogs with prices before any discounts. Let's assume that the supplier gives companies that purchase a high volume of goods a trade discount of 30%. A small volume buyer receives only a 10% discount. If a high volume company purchases $40,000 of goods, its cost will be $28,000 ($40,000 X 70%). To comply with the cost principle the company will debit Purchases (or Inventory) for $28,000 and will credit Accounts Payable for $28,000.

Early payment discount. Some suppliers offer discounts of 1% or 2% from the sales invoice amount, if the invoice is paid in 10 days instead of the usual 30 days. For instance, let's assume that a company purchases goods and the supplier's sales invoice is $28,000 with terms of 1/10, net 30. This means that the company can deduct $280 (1% of $28,000) if it pays the invoice within 10 days. Otherwise, the company must pay $28,000 within 30 days. The early payment discount is also referred to as a purchase discount or cash discount.

If the company pays the supplier's invoice within 10 days, there are two ways to record the early payment discount of $280:

• Gross method. At the time goods are received: debit of $28,000 to Purchases, credit of $28,000 to Accounts Payable. At the payment date within 10 days: debit of $28,000 to Accounts Payable, credit of $27,720 to Cash, credit of $280 to Purchases Discounts (a contra account to Purchases)
• Net method. (This method is used less often and only if the company has the resources to always pay within the discount period.) At the time the goods are received: debit of $27,720 to Purchases, credit of $27,720 to Accounts Payable. At the payment date within 10 days: debit $27,720 to Accounts Payable, credit $27,720 to Cash. [If the company fails to pay the invoice within the discount period, the payment will be a debit of $27,720 to Accounts Payable, a debit of $280 to Purchase Discounts, a credit to Cash for $28,000. Purchase Discounts Lost is an income statement account.]