Cash Discount (Prompt Payment Discount, Settlement Discount) – Definition, Calculation and its Types:
Cash discount sometimes called prompt payment discount. It is the difference between the trading (buying and selling) price of the goods sold and the amount actually paid for them. Cash discount is also called settlement discount as it is used to settle the outstanding balances of the supplier or customer as the case may be.
Cash discount is allowed by a supplier to encourage customers to pay within a certain time period. The customers can choose whether to take up the cash discount by paying promptly or whether to take longer to pay without cash discount. If the goods are traded with the possibility of a cash discount, the purchase or sales price is always recorded net of trade discount but at a pre-cash discount price. As a result when cash discount arises, it needs to be recorded in the accounts.
In order to calculate the amount to be paid or is expected to be received it is vital that the trade discounts are deducted first before calculating the cash discount.
Cash discount may be of two types:
(i) Discount Allowed: This is cash discount granted to customers on early payment. This is shown as an expense as it represents cost of collecting debts promptly.
(ii) Discount Received: This is cash discount received from suppliers on early payment. This is shown as an income as it represents benefit of paying debts early.
David sell goods to George on 23 January 2019, at a list price of $4800 but subject to a trade discount of 20% and a cash discount of 5% if amount is settled within 30 days. George paid on 15 February.
How much will George pay for the goods?
As payments is made on 15 February, whereas for getting discount; payment was to be settled before 23 February, so George will be entitled to cash discount @ 5%.