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Calculating Cash Discounts and Allowances

Cash discounts are sometimes called purchase discounts from the purchaser's perspective. Discounts are designed to encourage early payment and usually represent substantial savings. If a purchase was made on April 1, terms 2/10, n/30, the discount can be taken if payment is made between April 1 and April 10 - 10 days between these two dates. The discount cannot be taken from April 11 up to April 30, a time frame of 20 days. The invoice will become past due after April 30. Waiving a discount means ignoring savings for your company. For example, if a company is earning a 2% return by paying 20 days early, the annual interest is actually 36%, established by determining the number of twenty-day periods in a year (365/20 = 18 periods x 2% = 36%).

Discounts are offered in different terms, for example:

This example illustrates the calculation of the allowance for cash discounts. If a company, LifeSavers, LLC sells to wholesalers on terms of 2/15, net 30, it means that a 2% would be earned if paid within 15 days, net in 30 days. LifeSavers LLC, has no cash sales but 50% of LifeSavers take advantage of this discount. LifeSavers, LLC analyzed its account receivables balances at December 31, 2009, which revealed the following information:

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