A business has been invoiced by a supplier 500 for goods and services, and is given a 2% cash discount for early settlement.
The original invoice would have been posted to suppliers accounts payable account, which would therefore show a balance of 500 before the cash discount. A 2% cash discount on 500 is 10, and the amount of cash the business actually pays the supplier pays is 490.
A cash discount received, sometimes called an early settlement discount, is recorded in the accounting records using two journals. The first journal is to record the cash paid to the supplier. The second journal records the cash discount received to clear the remaining balance on the suppliers account.
Journal 1 Entry for Cash Paid
The accounting records will show the following bookkeeping entries when the cash is paid to the supplier after deduction of the cash discount received.
| Account | Debit | Credit |
|---|---|---|
| Accounts payable | 490 | |
| Cash | 490 | |
| Total | 490 | 490 |
Cash Paid Bookkeeping Entries Explained
Debit
The amount owed to the supplier (500) would have been sitting as a credit on the accounts payable account. The debit above reduces the balance on the accounts payable account to the amount of the cash discount received (10).
Credit
The cash is reduced by the payment to the supplier.
The Accounting Equation
The Accounting Equation, Assets = Liabilities + Owners Equity means that the total assets of the business are always equal to the total liabilities plus the equity of the business. This is true at any time and applies to each transaction. For this transaction the accounting equation is shown in the following table.
| Assets | = | Liabilities | + | Owners Equity |
|---|---|---|---|---|
| Cash | = | Accounts payable | + | None |
| – 490 | = | – 490 | + | 0 |
In this case an asset (cash) is reduced and, on the other side of the accounting equation, a liability (accounts payable) is also reduced by the payment made to the supplier.
Journal 2 Cash Discount Received Entry
The accounting records will show the following bookkeeping entries for the cash discount received when the discount is posted to clear the remaining balance on the suppliers account.
| Account | Debit | Credit |
|---|---|---|
| Accounts payable | 10 | |
| Discounts Received | 10 | |
| Total | 10 | 10 |
Cash Discount Received Bookkeeping Entries Explained
Debit
The balance of the amount owed to the supplier (500 – 490 = 10) would have been sitting as a credit on the accounts payable account. The debit above clears the amount due to the suppler and reduces the balance to zero.
Credit
The cash discount given by the supplier is a credit to the discount received account in the income statement, and reduces the expenses of the business
The Accounting Equation
The Accounting Equation, Assets = Liabilities + Owners Equity means that the total assets of the business are always equal to the total liabilities plus the equity of the business, this is true at any time and applies to each transaction. For this transaction the accounting equation is shown in the following table.
| Assets | = | Liabilities | + | Owners Equity |
|---|---|---|---|---|
| = | Accounts payable | + | Discounts received | |
| 0 | = | -10 | + | 10 |
In this case a liability (accounts payable) is reduced as the balance on the account is cleared, the discount received reduces the expenses of the business in the income statement, increasing net income, retained earnings and therefore the owners equity in the business.
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