Why Would The Answer Not Be $3,000 In This Accounting Problem?

the right answer is $2,940. If the customer was not able to pay within the discount period, why wouldn’t the cost recorded be 3,000?

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2 Responses to “Why Would The Answer Not Be $3,000 In This Accounting Problem?”

  1. Wizened wizard says:

    This answer cannot be found by arithmetic alone. Ordinary good business practice is to take advantage of the discount. The cost this way is $2,940.
    The question to ask is whether the product is more valuable if the company waits until the discount expires. Is it? Is it worth $3,000?
    Book the product at $2,940, and post the $60 in an expense category for discounts foregone.

  2. women_ar says:

    The question is not about the advisability of paying in time for the discount or not doing so like seems broadly assumed in the other answer. It is about what is what, so to speak, how things are defined.
    The (VERY) short answer is that it is $2,940 because of the very definition of “net price method.”
    In the way most people think about a cost, the price on the receipt (invoice, in business) is “the price.” $3,000 in this case. And that’s fine. It’s certainly the usual method of choice in business too. And, consider this: if you don’t pay on time, you expect there’ll be a penalty… interest. You would not, however, expect to call that interest part of the price of the item. You’d call it “interest expense” and maybe put a finer detail on it if you maintain that detailed a set of books. Additionally, even if the item were something (a desk, say) that the IRS expects to be depreciated rather than the whole expense taken this year, you’d depreciate the “price” amount and still expense the “interest” amount. You just flat wouldn’t think of the interest as part of the cost of the item, but rather the price of the very different decision, that of paying late.
    The net price method just takes this a wee step further conceptually. It says that the “price” from above is actually the “price” plus the first bit of “interest” for paying late. In other words, it doesn’t wait until you are late in the usual sense to start regarding part of your payment as interest, it says that the discount amount is EXACTLY the same as interest paid for any other reason, especially since, if you regard the end of the discount period as the due date, not, say, 30 days, then it literally is the very first part of the interest for being late.
    And since the discount amount is also interest, it is an expense related to when and how you pay, not to the item you bought (like a desk). So it never was part of the item’s cost, just the penalty for missing the payment deadline (the discount end date).
    So you record the cost as $2,940 and IF you miss the discount’s deadline, you begin recording interest. $60 in this case. But it is not now, nor was it ever, a part of the items “cost” (or “price”). That $60 was always “interest.” Interest you have to pay or do not but ALWAYS was, is, and always will be “interest.”
    So the proper answer is indeed $2,940 regardless of when it gets paid, if it ever actually does.
    By the way, you may see in the above why one might like this method: everything you can negotiate a discount on becomes slightly less costly so far as taxes are concerned. Every business that is privately owned prefers to write an expense against profits NOW rather than later to reduce the tax bill. Today’s tax bill. Tomorrow’s may be higher enough because of the choices to make it more costly overall, but that’s tomorrow’s short-sighted problem, eh? You may be dead tomorrow, right? On the other hand, a public company often wants the opposite: to inflate today’s profit by lowering today’s expenses in order to drive its stock price higher. That would be different if today’s companies paid dividends that had anything to do with profits, but they don’t. So stockholder rewards come from higher stock prices. So they WANT to force expenses into depreciable items so as to lower this year’s expenses raising profits. If those expenses cause problems next year, well, that’s NEXT year… you might be dead next year, eh? So that’s their short-sighted problem…
    But the (VERY) short answer is that it is $2,940 because of the very definition of “net price method.”
    I should mention that this method allows the constantly updated “discounts lost” to be used as a management tool as they represent inefficiencies in the office process. When it is “discounts taken” one has to compute those lost which is slightly harder.

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