[Anonymous]

1. How do you handle purchase discounts taken on invoices you pay early? I have generally seen them expensed in the month the invoices are paid especially when immaterial.

DR. Accounts Payable

CR. Cash

CR. Purchase discount (income statement usually in COGS)

2. On the other hand, I have also seen inventory values reduced.

DR. Accounts Payable

CR. Cash

CR. Inventory (obviously balance sheet)

I guess my take on this is that if we are really considering the matching principle there should be some sort of allowance account setup for purchase discounts in the same way that sales discounts match the revenue and not the month they are actually taken by the customer. Maybe I am dialing way too far in on this, but purchase discounts can be a pretty large account in a Fortune 500 company.

[SIMmer Down]

This way to success:

https://www.principlesofaccounting.com/illustrative%20entries/illustrative%20entry%20for%20purchases%20with%20discount%20%28gross%29.htm

https://www.principlesofaccounting.com/illustrative%20entries/illustrative%20entry%20for%20purchases%20with%20discount%20%28net%29.htm

[leglock]

At my company, we view a purchase discount as revenue with the offset to the liability

initial purchase
dr purchase 10,000
cr a/p 10,000

pay invoice with discount
dr a/p 10,000
cr cash 9,900
cr purch disct 100

We do not have it impact inventory because the thiking is that if another company buys that same inventory but is light on cash, there shouldn't be a disparity between our inv value and theirs just because we are more cash heavy.

[Anonymous]

Thanks for the responses.

@Simmer, yes I understand the entry, but I have seen it done multiple ways and both ways appear to be OK which is why I am wondering what others have seen at other companies.

@leglock but in reality, you should value the inventory at the lower of cost or market. I know I'm getting technical, but it seems odd to me that GAAP would accept recognizing an expense in the month that it is paid. That is more of a cash basis transaction when in reality we are accrual based and supposed to use the matching principle. When you say you code it to revenue, where do you have the line item show up on the income statement? Generally, I have seen it as an offset to COGS.

[Missy]

I do it the first way. I guarantee that at some point someone will ask for an analysis of whether taking the discounts is worthwhile (i.e. does the discount as a % exceed the interest rate if the money was earning interest in the bank for the number of days in the discount period).

If you apply the discount toward inventory its difficult if not impossible to create such an analysis.

Also,I prefer not to incorporate discounts into COGS (which is what lowering inventory ultimately does) for two reasons, it skews a costing analysis if you're helping to determine sales prices, if the policy suddenly changes and the company stops taking discounts you will see a reduced contribution margin,etc.

I think either way is technically “acceptable” but there are many benefits to using a purchase discounts account on the income statement. However recognizing the discount at the time of payment rather than at the time of inventory receipt is correct, since the very existence of the discount depends on the timing of the payment. If you don't pay on or before that date, no discount exists so I wouldn't recognize the discount at the point of receipt under any circumstances personally although I am sure some companies do.

Licensed Massachusetts Non Reporting CPA since 2012
Finance/Admin/HR Manager

[Anonymous]

Thanks mla.

I agree that recognizing the discount at the time of the payment is correct. I also agree that applying discounts to inventory “gums” up analyses, but a lot of what GAAP makes us do is more work. To me, it seems if you do not apply the discounts to inventory and you still have the inventory on-hand, you are overstating inventory value. If you do not have the inventory on-hand, then I would certainly expect it to show up on the income statement.

Think of a sales discount allowance. GAAP says that you must match the sales and estimated future discounts in the same reporting period. It seems odd to me that for sales discounts this is required but for purchase discounts it is not. Maybe I should write a technical report on it and submit it to the FASB. Lol! 🙂

[Anonymous]

Thanks mla.

I agree that recognizing the discount at the time of the payment is correct. I also agree that applying discounts to inventory “gums” up analyses, but a lot of what GAAP makes us do is more work. To me, it seems if you do not apply the discounts to inventory and you still have the inventory on-hand, you are overstating inventory value. If you do not have the inventory on-hand, then I would certainly expect it to show up on the income statement.

Think of a sales discount allowance. GAAP says that you must match the sales and estimated future discounts in the same reporting period. It seems odd to me that for sales discounts this is required but for purchase discounts it is not. Maybe I should write a technical report on it and submit it to the FASB. Lol! 🙂

[Missy]

Its really not overstating the inventory at all. A discount does not have to reduce the cost of inventory. It can. But if you buy something for $100 and get a $10 discount you are absolutely not overstating inventory by leaving it as $100. You are not required to incorporate the discount into cost (but you can). https://accountingexplained.com/financial/inventories/cash-discount-on-inventory-purchase

Here's why you take a sales discount (which is an expense) allowance up front. GAAP generally follows rules of conservatism. You have no control over whether a customer does or does not take a discount. So to err on the side of conservatism you assume everyone will. You CAN reflect a purchase discount (which is below the line income if you treat it that way) at the time of receipt but you are not required to. Most companies, again erring on the side of conservatism, will wait to reflect the discount taken at the time of payment. You're basically asking why a revenue isn't treated exactly the same as an expense. The answer is they don't necessarily have to be treated exactly the same as long as they're both acceptable by gaap, which they are. Some companies will do it along the lines of your thinking, others will do their own mix and match method.

Licensed Massachusetts Non Reporting CPA since 2012
Finance/Admin/HR Manager

[Author]

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