"Terms 2/10, n/30", at first-glance, looks like accounting gibberish.
In all actuality, it’s actually pretty simple.
First, we must understand the following:
Terms 2/10, n/30 is used in situations where the customer pays for an order on credit. It’s an incentive program to make the customer pay off their account at an earlier date.
In other words… we’ll only use terms 2/10, n/30 in situations where the customer pays for something on account, and we use Accounts Receivable to record it.
Next, we must understand the following:
Terms 2/10, n/30 mean that...
- If the customer pays their balance off within 10 days of purchase (terms 2/10, n/30)...
- ...they get a 2% discount (terms 2/10, n/30).
- Otherwise, they get charged the full amount.
- They're required to pay off the balance within 30 days (terms 2/10, n/30).
That’s the significance behind those numbers and such.
How to apply terms 2/10, n/30
Let’s get some practice with this in a simple example:
Question: On January 15th, Hats LLC makes a mass order for Sigma Apple Pi on account for $500, terms 2/10, n/30. Sigma Apple Pi pays Hats LLC for the mass order on January 20th. Record the collection of cash on January 20th.
First things first, we've gotta check if the 2% discount of terms 2/10, n/30 apply here!
Once you recognize you’re working with terms 2/10, n/30…
Question: On January 15th, Hats LLC makes a mass order for Sigma Apple Pi on account for $500, terms 2/10, n/30. Sigma Apple Pi pays Hats LLC for the mass order on January 20th. Record the collection of cash on January 20th.
…you should immediately check if they paid off their account balance within 10 days of the purchase (terms 2/10, n/30)!
In this case, the order was placed on January 15th, and paid off 5 days later on January 20th…
Question: On January 15th, Hats LLC makes a mass order for Sigma Apple Pi on account for $500, terms 2/10, n/30. Sigma Apple Pi pays Hats LLC for the mass order on January 20th. Record the collection of cash on January 20th.
…therefore, the customer will receive the 2% sales discount (terms 2/10, n/30)!
Considering they do, we must then calculate the sales discount that'll apply.
Considering that the sale was for $500…
Question: On January 15th, Hats LLC makes a mass order for Sigma Apple Pi on account for $500, terms 2/10, n/30. Sigma Apple Pi pays Hats LLC for the mass order on January 20th. Record the collection of cash on January 20th.
…2% of that is $10!
Sales Discount = $500 x 2% = $10
Once we determine the discount to be worth $10, we can move onto writing the journal entry for the transaction on January 20th!
We’re going to utilize the Sales Discounts account to record this 2% discount. Considering that Sales Discounts is a contra revenue account, it has a normal debit balance.
In other words, to add a discount to Sigma Apple Pi’s order, we must debit Sales Discounts by the $10 discount.
Now, we’ve factored in the discount for Sigma Apple Pi, but we’ve still gotta record Hats LLC receiving payment for the order.
Considering that Sigma Apple Pi “paid off their account” on January 20th, this means they paid in Cash. Therefore, this transaction is increasing Hats LLC’s Cash account balance, which has a normal debit balance. Therefore we must debit Cash…
…but by how much?
Well, Sigma Apple Pi received a 2% discount on their order (equating to $10). Therefore…
$500 (Order Amount) - $10 (2% Discount) = $490
Sigma Apple Pi paid Hats LLC $490 on January 20th!
Next, what account are we going to credit?
It helps here to view the initial journal entry that occured on January 15th at the time of purchase:
Notice how we increased our Accounts Receivable account by $500. Sigma Apple Pi made a purchase with Hats LLC on credit, and that’s why we added $500 to Accounts Receivable.
Now… on January 20th, Sigma Apple Pi has paid off that $500 balance. To make note of this with a journal entry, we’ll subtract $500 from Accounts Receivable, which has a normal debit balance. So to subtract, we’ll credit it!
This results in the following journal entry to record the collection of cash!
