There a number of transactions that can reduce the gross sales of a business, resulting in net sales. These transactions are most likely to arise for businesses that sell physical goods, and least likely for those that sell services. These transactions are clustered into the general categories of sales allowances, sales returns, and sales discounts, which are discussed below. The accounting for these transactions is to record them in a sales allowances, sales returns, or sales discounts account. For presentation purposes, they offset gross sales to arrive at net sales.
These discounts are not recorded as sales, but are instead recognized as a deduction from net sales. A sales discount may be offered by the seller because he does not have enough money to pay for the product. As seen in the financial report above, the sales discount as a contra revenue account appears as a $9 reduction from the gross revenue of $900 that the manufacturer reported, which results in net revenue of $891. Sales returns and allowances is a line item appearing in the income statement. This line item is presented as a subtraction from the gross sales line item, and is intended to reduce sales by the amount of product returns from customers and sales allowances granted.
- Hence, the general ledger account Sales Discounts is a contra revenue account.
- There are two main types of discounts in accounting that might occur in businesses such as trade discounts and sales discounts.
- This type of discount unlike the sales discount does not appear in the accounting records or on the financial statements specifically.
However, this is generally more confusing, so net sales are typically the only value presented. When gross sales are presented on a separate line, the figure is often misleading, because it tends to overstate the amount of sales performed and inhibits readers from determining the total of the various sales deductions. Gross sales are calculated by adding all sales receipts before discounts, returns, and allowances together.
For companies using cash accounting they are booked when cash is received. Some companies may not have any costs that will require a net sales calculation but many companies do. Sales returns, allowances, and discounts are the three main costs that can affect net sales. All three costs generally must be expensed after a company books revenue. As such, each of these types of costs will need to be accounted for across a company’s financial reporting in order to ensure proper performance analysis. For the recent year, the company had gross sales of $510,000 and had sales discounts of $4,000 and sales returns and allowance of $5,000.
What is Net Sales?
It is followed in the income statement by a net sales line item, which is a calculation that adds together the gross sales line item and the negative amount in the sales returns and allowances line item. If the customer pays within the 10 days and takes the sales discount of 50, then the business will only receive cash of 1,950 and accounts for the difference with the following sales discounts journal entry. It is a reduction of gross sales which correspondingly causes a decrease in the net sales figure. Sales discounts do not reduce any assets or liabilities, only revenue which reduces net income. However, these cash reductions offered to customers have an effect on a company’s financial statements so they must be recorded as a reduction in revenue under the line item called accounts receivable. As seen in the report above, the sales discount as a contra revenue account appears as a $1,500 reduction from the gross revenue of $30,000 that Company ABC reported, which results in net revenue of $28,500.
A sales discount takes place when a seller offers a reduction in the sales price to a customer as an incentive to pay an invoice within a certain time. A sales allowance is recorded when a customer complains about the condition of received goods, and negotiates for a reduced price. Since the seller has already booked the full amount of the sale, this reduction is recorded as a credit (reduction) of accounts receivable and a debit (increase) of the sales allowances account. A sales allowance is relatively uncommon; in many cases, a business may not choose to record these transactions in a separate account. Instead, they are recorded in a sales returns and allowances account, which lumps together all sales allowance and sales return transactions (as described next). When it comes to cash discounts, the seller is the one who offers the discount.
The Difference Between Gross Sales and Net Sales
Gross sales and net sales are, at times, confused and assumed to be similar. Net sales are derived from gross sales and are more important when analyzing the quality of a company’s sales. Gross sales on their own are not as informative, as it overstates a company’s actual sales because it includes several other variables that cannot essentially be classified as sales. These companies allow a buyer to return an item within a certain number of days for a full refund. The sales discount is based on the sales price of the goods and is sometimes referred to as a cash discount on sales, settlement discount, or discount allowed.
How confident are you in your long term financial plan?
A company may decide to present gross sales, deductions, and net sales on different lines within an income statement. If a company provides full disclosure of its gross sales vs. net sales it can be a point of interest for external analysis. If the difference between a company’s gross and net sales is higher than an industry average, the company may be offering higher discounts or realizing an excessive amount of returns compared to industry competitors.
Resources for Your Growing Business
In accounting, the terms “sales” and “revenue” can be, and often are, used interchangeably to mean the same thing. It is important to note that revenue does not necessarily mean cash received. A portion of sales revenue may be paid in cash and a portion may be paid on credit, through such means as accounts receivables. Gross sales can be an important tool, specifically for stores that sell retail items, but it is not the final word in a company’s revenue. Gross sales are not typically listed on an income statement or often listed as total revenue.
She’s written over 20 books including Reading Financial Reports For Dummies and Trading For Dummies. Lita was the content director for a financial services Web site, MostChoice.com, and managed the Web site, Investing for Women. As a Congressional press secretary, Lita gained firsthand knowledge about how to work within and around the Federal bureaucracy, which gives her great insight into how government programs work.
Accounting for sales discounts involves the identification, recognition, measurement, and disclosure of price reductions offered by a company to its customers as an incentive for prompt payment or other sales-related conditions. Sales discounts are often expressed as a percentage of the sales price and can be offered to encourage customers to pay their invoices within a specified period or for purchasing products in bulk. The income statement shows the total sales, including allowances and sales discounts, and subtracts sales discounts.
Therefore, the debit balance of the sales discount will be one of the deductions from sales (gross sales) in order to report the net sales. Sales discount as a contra revenue account is expected to have a debit balance rather than the usual credit balance of revenue. Companies that allow sales returns must provide a refund to their customer. A sales return is usually accounted for either as an increase to a sales returns and allowances contra-account to sales revenue or as a direct decrease in sales revenue. As such, it debits a sales returns and allowances account (or the sales revenue account directly) and credits an asset account, typically cash or accounts receivable.
This is most common in a retailing environment, where retailers routinely allow returns within a certain number of days of the initial purchase. The accounting for a sales return is to credit (reduce) the accounts receivable or cash account by the amount paid back to the customer, while debiting (increasing) the sales returns account. In addition, the returned goods are returned to inventory or scrapped, depending on their condition. Sales discounts are recorded in a contra revenue account such as Sales Discounts.
Accounting Terms: XYZ
Net sales reflect all reductions in the price paid by customers, discounts on goods, and any refunds paid out to customers after the time of sale. These three deductions have a natural debit balance whereas the gross sales account has a natural credit balance. An income statement is a financial statement that accrual accounting vs cash basis accounting reveals how much income your business is making and where it is going. The net sales figure on an income statement shows how much revenue remains from gross sales when sales discounts, returns and allowances are subtracted. For companies using accrual accounting, they are booked when a transaction takes place.