Discounts are probably the most popular selling tool in business. Without a doubt, many companies discount the price for their products or services in various forms, for example:
- Buy 1, get 1 free (and modifications),
- Get 10% off for purchases over CU 100 (and modifications),
- Gift vouchers,
- Settlement discounts (bonus for early payment or for cash payment),
- and many others.
What do discounts really mean for us, accountants?
In most cases, troubles.
The reason is that discounts directly affect measurement of various items in the financial statements and potentially the accounting treatment (timing and journal entries).
In this article, I explain how you should treat the discounts from the point of view of both seller and buyer.
My good friend, Prof. Robin Joyce added a bonus to this article.
We try to explain why discounting is not always that great and how you should decide on the amount of your discount based on your own margins and sales.
Maybe you’ll be surprised to find out that not every single business can afford discounting. Yes, it’s an expensive selling tool!
Sellers provide discounts
When a seller provides a discount, it directly affect the amount of his revenue.
Therefore logically, we should look to the standard IAS 18 Revenue or IFRS 15 Revenue from Contract with Customers for guidance.
Both standards specify that you should present the revenue net of discounts. Just refer to IAS 18.7 or IFRS 15.47 and following).
In other words, discounts reduce the amount of your revenue and do not represent cost of sales (or cost of promotion etc.).
For example, when you sell a machine for CU 100 and you decide to provide a discount of 3%, then you present a revenue of CU 97, and NOT the revenue of CU 100 and cost (of sales, marketing, whatever) of 3.
This rule seems very basic and very simple, yet its practical application can be challenging at some circumstances.
Let me give you some examples.
Example 1: Discount coupons
Imagine you run an e-shop with books. To support your sales, you send a discount coupon for CU 5 that your customers can use with every purchase over CU 100.
How should you account for the discount coupon?
In this particular example, you don’t recognize a provision in your financial statements for a discount at the time of distributing a coupon.
Why?
Because there’s no past event.
Remember, a customer would have to make a purchase over 100 and only then you have a liability to provide a discount of CU 5.
Instead, you simply recognize revenue net of CU 5 discount when a coupon is redeemed.
Example 2: Buy 1, get 1 free (or any free items)
Instead of giving discount coupons, you promise to deliver a book “Thai cuisine” for free with every purchase of “Thailand travel guide” for CU 50.
You normally sell Thai cuisine for CU 10, its cost in your inventory is CU 6 and the cost of Thailand travel guide is CU 35.
What do to now?
Under IAS 18, you simply recognize revenue for both books of CU 50 and cost of sales of CU 41 (35+6).
Cost of free item is not a marketing or promotion cost in this case, because a free item increases revenues (supports spending).
Under IFRS 15, the accounting treatment is the same if both books are delivered at the same time.
However, if you deliver Thailand travel guide in September and Thai cuisine in October due to low stock, then you would need to split the transaction price of CU 50 based on the relative stand-alone selling prices and recognize revenue accordingly.
More specifically:
Total stand-alone selling prices: CU 50+CU 10 = CU 60
Revenue allocated to Thailand travel guide: CU 50/CU 60*CU 50= CU 42 to be recognized in September.
Revenue allocated to Thai cuisine: CU 10/CU 60*CU 50 = CU 8 to be recognized in October.
Costs of sales are recognized accordingly.
Buyers get discounts
When buyers get discounts, it’s a totally different story.
We need to look at IAS 2 Inventories, IAS 16 Property, plant and equipment or other similar standards for guidance.
Both IAS 2 and IAS 16 prescribe that we should initially measure an item of PPE or inventories at its cost including purchase price. And, it’s net of discounts.
However, let me stop here.
You should examine the reason for getting a discount.
If you receive a discount as a reduction in the purchase price of inventories, then you should deduct it from their costs.
When discounts refund some selling expenses, then these discounts are not deducted from the costs of inventories, but treated as income.
Another consideration might relate to settlement discounts, i.e. discounts received from quick payment. They should not be treated as finance income, but again, they reduce the cost of inventories.
Example 3 Rebates on inventories
Supermarket wants to purchase 1 000 Chocobars. What is their cost, based on the following information:
Sales price per unit: CU 5
Volume discount per 1000 units: 10%
Settlement discount: 2% when paid within 30 days
Contribution for leaflet printing costs: 1%
If the supermarket intends to pay within 30 days, then it should reduce costs of inventories by settlement discount, too.
Contribution for leaflet printing costs is clearly refunding some selling expenses and therefore it should be treated as income, not as cost of inventories.
The costs of inventories is: CU 5*1 000 – CU 5*1 000*(10%+2%) = CU 4 400.
By IFRS
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