Discount in book keeping

Generally, the term discount is a reduction or deduction of some amount of money from the principal amount set.

It is a relief that is extended by one party commonly referred to as the seller of goods or services to another party referred to as the buyer.

Discount implies that the price to be paid is lesser that the catalogue price originally set. To enjoy the discounted price, the buyer has to meet some thresholds.

Sell of goods and a discount has a reason(s) which justify the reduced prices.

Discount is usually expressed in terms of a percentage of the selling price which means the cash amount paid as price is less than 100% per cent.

To compute the net price to be paid by the buyer,

Consider the gross price, then les the discount amount or its equivalent. This is presented as follows;

Net price= Gross Price-discount amount

Classification of discount

Broadly, discounts are categorized or discussed from two point of views. That is Accountancy perspective and Financial Management perspective

As per each point of view, specific examples of type of discounts are stated therein

Discount-Accountancy Viewpoint

Discount in the context of Accountancy is the deduction that is subjected to the selling price of a good or service. The amount deducted is usually based on the gross selling value of the product in question. The aim of a discount is to prompt quick payments or it is a way of appreciating the customer/client for purchasing goods in large quantities and also quick clearing of inventory from stores.

Based on the firm policy on pricing of goods or services, there are manifold types of discounts as discussed herein.

1. Percentage sales

Percentage sale is an approach of providing discount to the customer in form of a cut off of a certain proportion of the gross selling price. Such that let say a 20% discount on selling price is given if a certain purchase condition is met. Use of a percentage apparently looks more appealing to the customer for it appears more as compared to an absolute single figure of let say $2.00 reduction on the selling price. Sometimes the percentage may look very attractive even as a customer you may think that the seller is not making any profits. No, this cannot be the case. The rates are well calculated to ensure the margin is reasonable For example, saying an item is 50% off may sound like a more significant discount than saying it is $5 off, even if they amount to the same dollar value.

Discount Component

Illustration

Pull Together (PT) sells motor vehicle accessories. To increase the sales volume, the marketing manager proposed that the items be sold at a discount as follows

Spare part-A

If purchase goods for re-selling purposes of $100

Discount will be 7% of the total sales value

Jack bought motor accessories of part-A amounting to $300.

The net amount Jack paid for was $279 (ie 300-21). This is a discount component or monetary relief.

2. Prompt payment discounts

As the name suggests, this is a type of discount extended to a customer to lure him/her to pay a debt of goods sold on credit in a shorter period that planned. This is done by the seller of the goods/or services with the intention of avoiding financial losses if the customer defaults. To the side of the customer, he pays less which s a cash relief to him.

Discount Component

Illustration

Rosy ltd deals with horticulture goods.

Credit terms of sale

If pay goods bought on credit within 20 days, given a 8% of purchase price discount

If pay goods bought on credit within 30 days, given a 4% of purchase price discount

If pay goods bought on credit within 40 days, given a 2% of purchase price discount

If pay goods bought on credit after 40 days, given a 0% of purchase price discount

 

Waterways ltd had bought on credit flower made products whose retail price was $40,000. The sales manager feels that paying $40,000 was high and since Rosy ltd had an option to the customers, they could take advantage of. Therefore, the sales manager suggested that they pay Rosy ltd within the 20 days

The company did actually pay by the 17th since the data of purchase. So Waterways ltd paid 36,800 (ie 40,000-3,200).

3. Trade-in credits

Trade in credit discount is a relief that is extended to a customer by a seller whereby an old design of a good or property is exchanged with another of convenience to the customer either money wise or otherwise. What happens is that the customer surrender the old make or design or in other words what he does not want and goes for a new one or whatever he/she wants. For this kind of discount to work, the seller of the new product ties the new product with a discount such that if one brings the old make, the new make is disposed or sold to him or her at a reduced price.

Discount Component

Illustration

In January 2019, Moses moved to a new house. He decided to buy a new fridge and do away with the old one. Fridgers co ltd offered him a deal of selling him a new one by exchanging the old one with a new make at a price lower than the market price by 5%. If the market price of the new make was $5,200. Then Moses paid is $4,940. If his old fridge make market price was $4,940, then he has saved $260 to get a new fridge. 

 

4. Sales Overstock discount

This is a discount extended to the customer especially when the business in question want to do away with slow moving inventory in the stores/ or shelves. Therefore, the seller may sell the targeted items at a lower price to salvage some costs such as handling and storage cost.

So the seller’s aim is to at least recover the warehousing storage cost even if not 100% recovery. That means it is not even a must to recover all the storage costs but at least to mitigate some.

Discount Component

Illustration

Kola Cocco co ltd deals with a certain type of ready to drink product. Of late due to Covid-19 challenges sales had gone under for at about 60%. The management agreed to sale the remaining old inventory at a selling price of $8 per bottle instead of $15 as it was before. This is a loss of $8 per bottle but to the customer, he or she has been relieved a clean $7. This is a discount

5. Referral discounts

This is a financial boost that is given to a customer who refers other new customers to buy certain goods or services from a particular seller. First the customer could have dealt with the seller before by buying the same good. Then once the customer purchase the good or goods from the seller, further agreement is set such that any customer referred to the same seller an amount of cash or non-cash gift is paid to that customer. This incentive due to making referrals is a discount of some nature.

Discount Component

Illustration

Suppose Thomas purchased an Isuzu pick up from Issuzz dealers at $70,000 and agreed with the dealer that any other customer directly referred to the same dealer, a 10% of the purchase price by the new customer will be transferred to the original customer, Thomas.

In February of 2020, Thomas brought a customer who bought a similar Isuzu pickup only that the carrying capacity was lower. The purchase price was $45,000 which was paid by check. Therefore after one week the dealer transferred the 10% of the purchase price as agreed to Thoma’s bank account.

This implies that the price that Thomas paid of $70,000 was reduced to $65,500 (i.e 70,000-10%*45,000=4,500)

So in actual sense, the purchase price that Thomas paid was $65,500 and not the apparent $70,000 he paid initially. This is a discount.

 

6. Free shipping discounts

Free shipping discount is a financial relief which involves reduction of the selling price to the client or customer by encouraging him or her to purchase a certain minimum quantities of a good so as the seller to guarantee free shipping up to the customer’s destination. Businesses use free shipping as a discount so as to encourage customers to make online purchases. These discounts translate in to cheap goods. Most of the cases, the seller sets a minimum order cost or quantity starting point to help reduce the cost of free shipping.

Discount Component

Illustration

 Manufacturer’s minimum set Quantity-1,000 pieces of good P

Whoever purchases such quantities, the shipping will be free of charge

If a customer bought 10,000 units of the commodity and cost him let’s say $100,000. Further, shipping charges by the shipping company was $1,000 for the 10,000 units. Then the customer pays only $100,000 and not $101,000. This shipping cost of $1,000 is the discount or cash relieve.

7. Bulky Purchase Discounts

As the name suggests, it is a relief extended to a customer mostly by the wholesalers, manufacturers or suppliers when the former purchase goods in bulky form or in large quantities. But the qualification for that requires meeting certain thresholds. For example, a 10,000 unit purchase can carry a 10% discount on the total cost of the units. Some large retail and grocery businesses have created customer loyalty and subscription programs and offer bulk items at a discount for members.

Discount Component

Illustration

Multiple co ltd is a firm that deals with gas products. Its terms of bulky purchases to its customers is

Selling price per ton $1.60

For the first 50 tons of gas purchased, no  discount

Next 100 tons bought, discount is of 5% of the total cost

Next 200 tons and above bought, discount is of 10% of the total cost.

Meli co. ltd purchased 230 tons of gas for re-selling purposes.

8. Seasonal discounts

Seasonal discount is a relief extended to a customer during certain unique seasons such as Christmas. At this time the buyer is given a privilege to purchase a good at a lower price. The condition here is that you purchase the number of items you so wish but within a specific period of time. Let say within the festive season or any other season set.

Discount Component

Illustration

December co Ltd gave an offer of 20% off the selling price of all its cloth inventory from 20th/ to 24th of the month of December 2021.

Total retail price for all the inventory during that festive season was $12,000. All the clothes were sold during that season. Therefore, the total cost paid by all the customers was;

12,000-(20%*12,000)= $9,600

The discount element was $2,400.

9. One for every two bought free sample

This is a type of relief or discount extended to the customer whereby the condition of enjoying an extra free good, he or she has to meet some set targets. That is, as the name suggests, buy two you get an additional free item/good of the same kind or a less valued similar good. For example, if you buy a detergent of 2Kgs, you are given an additional 500 grams of the same type of detergent.

Discount Component

The question is, how is this approach a discount?

To understand this concept, the following illustration will demonstrate that

XCC co Ltd sells detergents for domestic use. The packaging and the retail selling price to the final consumer is as follows;

NB: That although Martha bought a 5 Kg detergent, and actually paid $5.00, the additional free detergent of CC-3 detergent which had a market price of $1.50 reduced the original price burden from $5.00 to $3.50 (i.e 5.00-1.50). This is a discount.

 

10. Loyalty program discounts

Loyalty discounts arises when the seller want to retain his/her customers who buy a particular product in a consistent manner. This is achieved by ensuring that the customers are given some monetary or non-monetary benefits for being members. This is very common in commercial banks. The system works through creation of a customer based loyalty related program which can vary from one case to another. But the bottom line is that as long as you are a member, you enjoy some benefits such as reduced charges, reduced purchase price e.t.c

 

Discount Component

Illustration

Standard Chartered bank has Elite club for sports athletes. Members are supposed to enjoy the following privileges

Cold drinks when waiting to be served

Enquiry of account balance service free of charge-other normal customers pay 0.2% per enquiry

Free check drawing by customer-other normal customers pay 3% of the value of the check.

Wilberforce who has an account with Standard Chartered bank and a member of Elite club has a bank balance of $25,000

On 23th/12/2020 he drew a check to pay his workers of $5,000. He even first of all did enquire of the current balance before writing the check.

In this case, if he was an ordinary customer of the bank, he would have paid the following amounts for the two nature of services;

Bank balance inquiry fee .2%*25,000=$50

Check writing                   3%*5,000  =$150

The net bank balance would be 25,000-5,000-50-150=$19,800

However, now that Wilberforce is a member, the net bank balance after all those transaction will be $25,000-5,000=20,000.

Therefore, $200 is the discount component.

 

Types of Discounts

In Accountancy spheres, there are several types of discounts under which relief to the buyer are discussed as detailed in our  platform. This are;

1; Quantity Discount

2. Trade Discount

3. Cash Discount

 

Discount-Financial Management Viewpoint

Discount in the context of Financial Management (Corporate Finance) is the deduction that is subjected to the intrinsic value of security of financial instrument such as bonds. First of all, a bond is a long term source of funding of a business just like ordinary shares and preferred shares. 

In Finance, the commodity on sale is the financial instruments and they are characterized by three types of values, namely;

Par value

Book value

Intrinsic/market value

Before further elaborate on of how discount works with financial instruments, I will explain these three values first and then connect to discount element

Par value is the face value of an instrument. It is the price per security that is pre-determined by the promoters of the company and it is fixed. In other words it does not change with change in the market forces of demand and supply. This price/value is also referred to as nominal or par value and essentially, it is used in determining the amount of returns to be paid to the respective investors as per each source of finance.

In the books of accounts, the financial statement such as statement of financial position portrays this prices/value clearly as follows;

The par value is the @10, @100 and @100 for ordinary, preference and bond securities respectively. This price/value is always constant

 

Book Value is the total value of all assets which represent capital plus liabilities used to finance the latter. You see in accounting A= C+L. So the total value of C+L is equal to A. But Assets value are affected by issues such as depreciation hence the book value is the original value less any depreciation at the end of the year. Such that even if the starting book value was the same as the nominal value of the sources of finance, the end result will be lower.

 

Intrinsic value is the true value of a security for the time you hold it. The true value is normally determined by the forces of demand and supply hence it is sometimes referred to as the market price. In other words, the question that one should ask himself is, how much monetary value can you realize from the asset or security you have invested in in case you decide to dispose/sell it.

 

Now, in Finance, we assume that the market price represents the intrinsic value. But sometimes the market value is not given.

If this be the case, then we can also determine the intrinsic value (assume to be the market value) by discounting all the future cash flows associated with this financial instrument.

Again you ask yourself, which is this future cash flows that you expect and the answer is simple the cash flow in form of returns, commonly known as coupon rate and the principle amount that is refunded by the issuing firm. In other words the present value of all future cash flows originating from that security

 

At the time of issuing or selling the financial instrument such as bonds to raise capital, the firm can issue at par/nominal price, or at a premium or at a discount.

 

Further Clarification

If issue at par, the cash realized will be the same as the nominal value of all the securities

If issue at premium, the cash realized will be the more than the nominal value of all the securities

If issue at a discount, the cash realized will be less than as the nominal value of all the securities

Illustration

Issue of Bond at nominal price, the total cash received will be 10,000,000 (1,000.000*10)

Assume discounted price is $90. Then issue of Bond at a discount, the total cash received will be $9,000,000. This means the issuing firm will raise less capital than when it issues at par.

In conclusion, in Finance, discounts are meant to raise capital in a more faster manner by making the financial instrument to be cheap

Advantages of discount

Accounting perspective

1. Help in customer retention which lead to increased market share which assures the business management of profitability
2. Remain competitive in the market-discounts ensures that as a firm you remain in the market for any thing less than this approach will mean being outcompeted and made non-operational
3. Build good reputation-when discounts are extended to the customer, it builds a good name and this increases royalty by customers
4. Attain the set goals on sales
5. Avoid financial losses-discounts ensure that probability losses in terms bad debts written off is minimal
6.Reduce handling and store cost

Financial perspective

1. Help in raising finances-discounts help to raise funds easily for the prices have gone down hence cheap for the investors
2. Discounts are a booster in ensuring that the firm can meet its debt obligations as and when they fall due
3. The amount of discount given is usually impaired or written off and it is a tax allowable expense

Disadvantages of discount

1.Loss of profitability-when goods or services are discounted, it is the business that losses profitability and this can lead to closure if it is practiced every other time.
2.Bad implication of poor quality goods-the continuous provision of discounts may result to customers thinking that you sell goods or services of low quality and this can adversely affect the sales volume
3.Waste of resources-extreme provision of discounts result to waste of resources for you should not forget that the business spend its resources to create the goods and services and giving the goods or service with discount is not 100% ok.
4.Raising of less financing-in finance, if we issue securities at a discount, then less capital will be realized unlike if it was issued a par or premium. Therefore it is not an economical way of raising finances for the organization.