Net Method of Recording Accounts Payable
The net method of recording accounts payable is an accounting method that records the purchase of goods or services at the net price, assuming any available discounts will be taken. The net price is the total invoice cost less any discounts for early payment.
For instance, a company might buy goods worth $1,000 on terms of “2/10, net 30”. This means the seller is offering a 2% discount if the bill is paid within 10 days, otherwise, the full amount is due in 30 days.
Under the net method, the company records the payable from the beginning at the discounted amount of $980 ($1,000 less 2% of $1,000). If the company pays within the discount period, there’s no further action needed. However, if the company doesn’t take the discount and pays the full $1,000 at the end of 30 days, the difference of $20 ($1,000 – $980) is recorded as an expense, often under “Interest Expense” or “Lost Purchase Discounts.
The net method assumes that discounts will be taken, and any missed discounts are explicitly recorded as a cost to the company. However, it’s worth noting that in practice, the gross method (which records payables at the full invoice amount) is used more frequently, due to its simplicity and the fact that many companies don’t take every discount available to them.
Example of the Net Method of Recording Accounts Payable
Let’s go through an example of how the net method would be used.
Let’s say a company named “BikeMaster” purchases $5,000 worth of bike parts from a supplier. The supplier offers terms of “2/10, net 30”, meaning that they’re offering a 2% discount if the invoice is paid within 10 days. If not, the full amount is due in 30 days.
Under the net method, BikeMaster initially records the purchase at the discounted amount:
$5,000 – ($5,000 * 0.02) = $4,900
The journal entry to record the purchase would be:
- Debit Inventory: $4,900
- Credit Accounts Payable: $4,900
Now, two scenarios can happen:
- If BikeMaster pays the invoice within 10 days, they take advantage of the 2% discount. They pay the supplier $4,900, and the journal entry to record the payment would be:
- Debit Accounts Payable: $4,900
- Credit Cash: $4,900
- If BikeMaster pays the invoice after 10 days, they have to pay the full invoice amount of $5,000. They missed the discount, so they need to record that missed discount as an expense. The journal entries to record the payment would be:
- Debit Accounts Payable: $4,900
- Debit Lost Purchase Discounts (or Interest Expense): $100
- Credit Cash: $5,000
In the second scenario, the extra $100 that BikeMaster paid because they missed the discount period is recorded as a separate expense. This provides more information about the company’s operations, specifically its ability (or inability) to take advantage of offered discounts.