Net Price Method
The net price method, also known as the net method, is an accounting technique used to record purchases and discounts. Under this method, purchases are recorded at their net price, which is equal to the gross price (the original price) minus any purchase discounts available.
A purchase discount is a deduction that a vendor allows on the invoice amount to encourage prompt payment. This is usually expressed as a percentage and is typically provided for in the terms of sale.
For example, terms like “2/10, n/30” mean that a 2% discount is available if the invoice is paid within 10 days. If not paid within 10 days, the full (net) amount is due within 30 days.
Under the net price method, if a company purchases goods for $1,000 with terms 2/10, n/30, the purchase is recorded as $980 ($1,000 less 2% of $1,000). If payment is made within the discount period, no further action is required. However, if payment is made after the discount period, the company would record the loss of the purchase discount as an expense or interest charge.
This method contrasts with the gross price method, where purchases are initially recorded at their gross price and a purchase discount is only recorded if payment is made within the discount period.
The net price method is more consistent with the principle of conservatism in accounting, which stipulates that expenses and liabilities should be recognized as soon as they are incurred, but revenues should only be recognized when they are assured. However, it requires more diligent tracking of payment dates and can make bookkeeping slightly more complicated.
Example of the Net Price Method
Imagine a company, “ABC Retail”, purchases inventory worth $1,000 from a supplier. The supplier offers terms of 2/10, net 30. This means ABC Retail can take a 2% discount if they pay the invoice within 10 days, but the full amount is due in 30 days.
Under the net method, ABC Retail would record the purchase at the discounted price, which is the net price:
$1,000 – ($1,000 * 2/100) = $980
The journal entry would be:
- Debit Inventory $980
- Credit Accounts Payable $980
Now, two scenarios can occur:
- ABC Retail pays within 10 days:ABC Retail would then record the payment as follows:
- Debit Accounts Payable $980
- Credit Cash $980
- ABC Retail pays after the discount period, but within the full credit period:ABC Retail didn’t take advantage of the discount, so it owes the additional amount. ABC Retail would then record the payment and the missed discount as follows:
- Debit Accounts Payable $980
- Debit Purchase Discounts Lost (or Interest Expense) $20
- Credit Cash $1,000
