Definition of Discount Allowed
Discount Allowed refers to a reduction in the amount payable by a customer as an incentive for certain behaviors such as early payment or bulk purchasing. The goal is to encourage timely payment and large volume purchases. In accounting, this discount is recorded as an expense and is shown in the profit and loss account, thereby reducing the company’s total revenue for that period.
Key Points:
- Encourages early payments and bulk orders.
- Recorded as an expense.
- Shown in the profit and loss account.
Examples
- Prompt Payment Discount: A company offers a customer a 2% discount on the invoice amount if the payment is made within 10 days. For a $1,000 invoice, the customer would pay $980 if payment is made promptly.
- Bulk Purchase Discount: A retailer offers a 5% discount on orders over 1000 units of a product. A client purchasing 1200 units of the commodity priced at $10 each would receive a $600 discount, paying $11,400 instead of $12,000.
Frequently Asked Questions (FAQs)
Q1: Is Discount Allowed reflected in the revenue section of the income statement?
A1: No, Discount Allowed is usually reflected as an expense in the profit and loss account, reducing the company’s total revenue.
Q2: What is the difference between Discount Allowed and Discount Received?
A2: Discount Allowed is given by the company to its clients, acting as an expense. Discount Received, on the other hand, is received by the company from its suppliers, reducing the company’s expenses.
Q3: Why do companies offer discounts like these?
A3: Companies offer these discounts to incentivize quick payments and increase sales volumes. This can improve cash flow and reduce inventory holding costs.
Q4: Can discounts allowed affect the profit margins of a company?
A4: Yes, offering too many discounts or large discounts can significantly impact the profit margin since it reduces the gross revenue.
- Discount Received: This is a reduction in expense granted to a company by its suppliers for early payment or bulk purchasing, recorded as a gain in the profit and loss account.
- Trade Discount: A discount on the listed price of goods or services offered by sellers to buyers, generally not recorded separately in accounting records.
- Cash Discount: Similar to a prompt payment discount, it is offered to customers for paying their dues before a set deadline.
- Profit and Loss Account: A financial statement summarizing the revenues, costs, and expenses incurred during a specified period, showing net profit or loss.
Online References
- Investopedia – Cash Discounts
- AccountingTools – Discount Allowed
- Corporate Finance Institute – Accounts Receivable Discount
Suggested Books for Further Studies
- “Accounting Made Simple: Accounting Explained in 100 Pages or Less” by Mike Piper
- “Financial Accounting, 10th Edition” by Walter T. Harrison Jr. and Charles T. Horngren
- “Advanced Accounting” by Floyd A. Beams, Joseph H. Anthony, Bruce Bettinghaus, and Ken A. Smith
Accounting Basics: “Discount Allowed” Fundamentals Quiz
### When a company offers a discount for early payment, where is this recorded?
- [ ] As revenue
- [x] As an expense
- [ ] As a liability
- [ ] As an asset
> **Explanation:** A discount allowed for early payment is recorded as an expense in the profit and loss account.
### What is a typical purpose of a "Discount Allowed"?
- [ ] To increase invoice amounts
- [x] To encourage early payment or bulk purchases
- [ ] To increase tax liabilities
- [ ] To decrease supplier expenses
> **Explanation:** The primary purpose of a Discount Allowed is to encourage early payments from customers or to incentivize bulk purchases.
### How does a Discount Allowed affect a company's profit and loss account?
- [ ] It increases total revenue
- [x] It reduces total revenue
- [ ] It has no effect
- [ ] It is recorded as an asset
> **Explanation:** Discount Allowed is an expense that reduces the company's total revenue in the profit and loss account.
### Is a Discount Allowed the same as a Discount Received?
- [ ] Yes, they are the same
- [ ] No, they are both liabilities
- [x] No, Discount Allowed is offered to customers, while Discount Received is granted by suppliers
- [ ] Yes, both reduce revenue
> **Explanation:** Discount Allowed is an expense offered to customers, while Discount Received is a reduction in expense given to the company by its suppliers.
### Where would you find Discount Allowed in financial statements?
- [ ] In the balance sheet
- [x] In the profit and loss account
- [ ] In the cash flow statement
- [ ] In the inventory records
> **Explanation:** Discount Allowed appears in the profit and loss account as an expense.
### What happens to the net revenue when a company offers a Discount Allowed?
- [x] It decreases
- [ ] It increases
- [ ] It remains the same
- [ ] It turns into an asset
> **Explanation:** Offering a Discount Allowed decreases the net revenue because it is recorded as an expense.
### Why might businesses opt to offer a Discount Allowed on bulk orders?
- [ ] To reduce tax liabilities
- [x] To increase sales volume
- [ ] To limit inventory space
- [ ] To increase supplier expenses
> **Explanation:** Businesses offer discounts on bulk orders to encourage higher sales volumes and reduce inventory holding costs.
### Can consistently high Discount Allowed negatively impact a business?
- [x] Yes, because it reduces profit margins
- [ ] No, as it boosts revenue
- [ ] Yes, because it results in financial redundancy
- [ ] No, it always benefits cash flow
> **Explanation:** Consistently allowing high discounts can reduce profit margins and potentially hurt the financial health of a business.
### Which statement is true regarding Cash Discounts and Discount Allowed?
- [ ] Both are recorded as assets
- [ ] Both increase net income
- [x] Cash Discounts often relate to prompt payments, which then lead to Discount Allowed being recorded as an expense
- [ ] Neither affects financial statements
> **Explanation:** Cash Discounts lead to Discount Allowed as an expense recorded in the financial statements for prompt payments.
### How does a Discount Allowed usually benefit a company's cash flow?
- [x] By encouraging faster payments
- [ ] By increasing product pricing
- [ ] By reducing inventory cost
- [ ] By postponing cash collection
> **Explanation:** Discount Allowed benefits a company’s cash flow by encouraging customers to pay faster, which improves liquidity.
Thank you for exploring the comprehensive understanding of “Discount Allowed” and tackling our thorough quiz. Keep pushing forward in your accounting expertise!
