Definition: Discounts lost are expenses that occur because a cash discount was not taken. In other words, it’s the difference between the full invoice price and discounted price of a product when a sales discount is offered.
What Does Discounts Lost Mean?
You might be thinking that a discount not taken shouldn’t be recorded as an expense because it violates the cost principle. Why would a company record an expense for something that wasn’t taken?
Well, thanks for asking. The discounts lost expense is only recorded when using the net method to record purchases and invoices. The net method records all transactions as if the discount was taken. In other words, it assumes the company took advantage of the early pay cash discount and records the transaction at the lower, discounted purchase price.
If the company uses the net method and doesn’t actually take advantage of the discount, the purchase needs to be grossed up to the actual purchase price according to the cost principle. Thus, the discount lost account is used to record the expense associated with grossing the purchase up the actual purchase price.
Let’s take a look at an example.
Josh’s Brewery purchases supplies from a vendor once a month for $2,000. Josh has been a long-term customer and the vendor has a good relationship with him, so the vendor offers Josh a 10 / 10, n / 30 discount. Usually Josh takes advantage of the discount, so he uses the net method to record the transaction like this.
Debit materials $1,800
Credit accounts payable $1,800
This month Josh is running low on cash, so he can’t pay his invoice within 10 days. Thus, he has to pay full price or $2,000 for the order. The problem is Josh only recorded the order for $1,800. Josh uses the discounts lost account to gross up the materials purchase to the full selling price like this:
Debit discounts lost $200
Credit accounts payable $200
Now Josh’s account payable account has a balance of $2,000 showing that he owes the vendor for the full amount.