TREATMENT OF CASH DISCOUNTS
73. Cash discounts are discounts allowed for prepayment of bills. They are frequently confused with bank discounts (or interest collected in advance when notes are discounted), but are of an entirely different character.
When the price is made, the profits are calculated with the idea that the customer may take advantage of the cash discount; that is, the price after the discount is deducted includes a legitimate profit. We cannot debit the customer with the amount of the bill less the discount, for we do not know that he will take advantage of the discount; and so, the charge to the customer and credit to sales account is an amount which may never be received.
If the bill is paid less the discount, the amount deducted reduces our profit on the sale. It is not an allowance for the use of capital, for we can probably borrow money at 6 per cent, while the discount may be 5 per cent or more for anticipating payment 30 days or less. 74. Discounts Allowed. Cash discounts allowed must eventually come out of the profits arising from the sale of the commodities in which we are trading. There are two methods of charging cash discounts, either of which is considered correct:
(1) Open an account called Discounts on Sales, and charge to it all discounts allowed for the prepayment of bills. When the books are closed, the total will be charged against trading profits. This method is coming into general use, and may be considered standard.
(2) Charge to Sales Account directly all discounts allowed, treating them as allowances. The balance of the sales account will then represent net sales after returns, rebates, and cash discounts have been deducted. One feature to recommend this plan is that sales account does not show a fictitious volume of sales.