Definition of Net Method
Example of Net Method
Assume that a company purchased $1,000 of goods on credit. The vendor's invoice shows the amount of $1,000 along with credit terms of 2/10, net 30 days. This means the $1,000 is due within 30 days, but if the company pays the invoice within 10 days, only $980 needs to be paid. ($980 is the "net" of the $1,000 invoice amount minus the early payment discount of $20, which is 2% of $1,000.)
Companies that use the net method will record the vendor's invoice as follows: credit Accounts Payable for $980 and debit another account (Inventory, Purchases, etc.) for $980.
If the company's policy is to pay all vendor invoices within the discount period, the net method will result in a more precise current liability amount on its balance sheet. It also means that the accounts and amounts recorded as debits will better reflect the historical cost principle.
If a company uses the net method, but fails to remit the net amount within the discount period, the net method requires a debit entry to the expense Purchase Discounts Lost. In our example, if the company pays the invoice in 30 days, it is not entitled to the early payment discount and will therefore have to credit Cash for $1,000. The debit amounts include Accounts Payable for $980 and Purchase Discounts Lost for $20. Any amount recorded in Purchase Discounts Lost informs management that its policy of paying within the discount period has been violated.
Although the net method is theoretically better, it seems to be less efficient than recording vendor invoices at their stated amounts.