Discount in Accounting

Definition of Discount

In accounting, the term “discount” carries various specific meanings:

1. Bill of Exchange Discount: A reduction taken when a bill of exchange is bought before its maturity date. The buyer pays less than its face value, profiting upon maturation. The discount amount encompasses interest calculated at the bill rate over its remaining term.
2. Price Reduction: Discounts offered to customers can include cash discounts for early payments, trade discounts for industry members, and quantity discounts for bulk purchases. Examples include:
   • Cash Discount: Price reduction for immediate or early payment.
   • Trade Discount: Special pricing for industry peers and frequent buyers.
   • Quantity Discount: Reduced rates for purchasing in large volumes.
3. Present Value Adjustment: Converting a future monetary sum to its present worth using discounted cash flow techniques.
4. Security Market Price Discount: The difference when a security’s market price is below its par value. For instance, a £100 par value bond priced at £95 is said to be at a 5% discount.

Examples of Discounts

• Cash Discount Example: A supplier offers a 2% discount if an invoice is paid within 10 days instead of the usual 30 days. Therefore, on a $1,000 invoice, $20 is discounted if paid early.
• Trade Discount Example: A wholesaler gives a 10% discount to retailers on their book prices—$50 books sold to retailers at $45.
• Quantity Discount Example: A manufacturer offers a $100 device with a 5% discount for orders of 100 units, equating to $95 per device for bulk orders.

Frequently Asked Questions about Discount

1. What is a trade discount?

• A reduction in the list price given to customers who are part of the industry or trade.

2. How is a cash discount applied in accounting?

• A cash discount is recorded when an invoice is paid earlier than usual, reflecting reduced receivables and a lower cash outflow.

3. What is the difference between a trade discount and a cash discount?

• A trade discount is an upfront price reduction for frequent, industry-specific purchases, while a cash discount incentivizes early payment of invoices.

4. What is a bill of exchange discount?

• It’s a deduction taken when purchasing a bill before it matures, capturing interest over the remaining period and reflecting anticipated income in future.

5. How does discounting affect financial statements?

• Discounts reduce revenue, accounts receivable/payable or investment values, impacting profit and loss statements and balance sheets.

Related Terms and Definitions

• Discount Allowed: Amount deducted from billings to customers as an incentive for prompt payment.
• Discount Received: Discounts availed from suppliers for early payments or bulk purchases.
• Present Value: Current worth of a future sum of money or stream of cash flows, given a specific rate of return.
• Par Value: Nominal or face value of a bond or stock, as opposed to its market value.

Online Resources

• Investopedia - Discount Definition
• Corporate Finance Institute - Types of Discounts
• Wikipedia - Discount

Suggested Books for Further Studies

1. “Accounting Made Simple: Accounting Explained in 100 Pages or Less” by Mike Piper
2. “Financial Accounting: An Introduction” by Pauline Weetman
3. “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
4. “Accounting for Dummies” by John A. Tracy
5. “Principles of Accounting” by Belverd E. Needles, Marian Powers

Accounting Basics: “Discount” Fundamentals Quiz

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