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What is a purchase discount?

A purchase discount is a deduction that may be available to a buyer if the buyer pays an invoice within a prescribed time. For example, a supplier's invoice for $10,000 with the credit terms 2/10 net 30 indicates that the buyer will be allowed a purchase discount of $200 (2% of $10,000) if the buyer pays within 10 days. If the buyer pays in 30 days, there is no purchase discount.

Under a periodic inventory system, the purchase discount on merchandise purchased is credited to the general ledger account Purchase Discounts. The credit balance in this account (along with the credit balance in the Purchase Returns and Allowances account) will be deducted from the debit balance in the Purchases account in calculating the amount of net purchases.

A purchase discount of 2% for paying 20 days early (paying in 10 days instead of 30 days) equates to an annual rate of 36%. A purchase discount of 1% for paying 20 days early means an annual rate of 18%.

While the buyer refers to this as a purchase discount, the seller will refer to it as a sales discount. The discount is also known as an early-payment discount or a cash discount.