Purchase Discounts – How do you handle them?

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  • #199540 Reply
    Anonymous
    Inactive

    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.

    #754880 Reply
    SIMmer Down
    Member
    #754881 Reply
    leglock
    Participant

    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.

    #754882 Reply
    Anonymous
    Inactive

    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.

    #754883 Reply
    Missy
    Participant

    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.

    Old timer,  A71'er since 2010. Licensed since 2012-non reporting MA CPA.

    Finance manager/HR manager

     

     

    #754884 Reply
    Anonymous
    Inactive

    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! 🙂

    #754885 Reply
    Anonymous
    Inactive

    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! 🙂

    #754886 Reply
    Missy
    Participant

    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.

    Old timer,  A71'er since 2010. Licensed since 2012-non reporting MA CPA.

    Finance manager/HR manager

     

     

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