Accounting for an early payment discount

Like I mentioned under the accounting entry for simple collection for receivables, there are times when recognizing a collection of a receivable balance can mean that you also have to make not only asset based entries, but also an entry to your profit and loss accounts.  

Say that you’re giving some of your customers an early payment discount (i.e. ‘cash discount’). A cash discount essentially means that should they pay within determined days and not on the final due date, they will get say 2% discount from their purchase. It’s their option to use and not something they may be using at all times.

Should a customer use it however, your accounting entry would look something like this (presuming that the initial receivable was 1,000 CU and they’ve paid within determined days thus presuming a 2% discount and paying just 980 CU):

# Debit-Credit Account name Amount 
1 Debit Discount expense  20
  Debit Cash and cash equivalents 980
  Credit Accounts receivable 1,000

 

A cash discount is useful in situations where you’re in fact in need of cash and to improve your liquidity you promise an incentive to your customers for giving theirs to you earlier than they normally would.