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2/10 Net 30

A trade credit that gives a 2% discount if payment is received within 10 days

What Does 2/10 Net 30 Mean?

2/10 Net 30 refers to the trade credit offered to a customer for the sale of goods or services. 2/10 net 30 means that if the amount due is paid within 10 days, the customer will enjoy a 2% discount. Otherwise, the amount is due in full within 30 days.

 

2/10 Net 30

 

Example of a Trade Credit

The CEO of Company A faces decreasing sales due to fierce competition in the marketplace. The CEO believes that the reason sales are declining is due to the company not offering trade credits. In fact, Company A is the only company in the industry that does not offer trade credits to customers. Knowing this, Company A sets up a new trade credit term for customers – 2/10 net 30. Customers who purchase on credit are given 30 days to settle their obligation. However, if paid within 10 days, customers would enjoy a 2% discount on the goods purchased.

If a customer purchases $10,000 from Company A on the terms 2/10 net 30 and pays within 10 days, the customer only needs to pay $10,000 x 0.98 = $9,800. On the other hand, if the customer pays after 10 days, he must pay the full amount of $10,000.

 

Journal Entries for Trade Credit

There are two methods of accounting for discounts: Net method and Gross method.

Let us consider the following example:

A customer of Company A, realizing that the company is offering credit terms of 2/10 net 30, decides to make a purchase of $1,000. The net method and gross method journal entries are provided below:

 

The net method records the receivables at the sale price less the cash discount. The company would need to make an adjustment for the interest earned if the customer does not take advantage of the discount.

 

The initial journal entry:

 

Net method - Initial journal entry

Note: $1,000 x 0.98 = $980. The net method records the receivables at the sale price less the cash discount.

 

If the customer pays within 10 days and takes advantage of the 2% discount:

 

Net method - 2% discount

 

If the customer pays after 10 days and does not take advantage of the 2% discount:

 

Net method - Full payment

 

The gross method records the face value of receivables. If the customer takes advantage of the discount, the company will reduce its revenue in the income statement.

 

The initial journal entry:

 

Gross method - Initial journal entry

Note: The gross method records the receivables at face value.

 

If the customer pays within 10 days and takes advantage of the 2% discount:

 

Gross method - 2% discount

Note: Cash discount goes on the income statement to reduce revenue.

 

If the customer pays after 10 days and does not take advantage of the 2% discount:

 

Gross method - Full payment

 

The Importance of Offering Trade Credit

From a supplier’s perspective, a trade credit is offered to facilitate more frequent and higher volume purchases. The flexibility in the time of payment attracts more customers and generates more sales for the company.

From a purchaser’s perspective, trade credit allows buyers to make purchases without immediately parting with their cash. Therefore, it also offers flexibility in that buyers can make purchases when there is no cash on hand.

 

The Risk in Offering Trade Credit

The biggest risk to a supplier when offering trade credit is the potential for bad debt. Since cash does not immediately switch hands in a purchase, the buyer may end up not paying for the purchases. When companies offer trade credit, an allowance for doubtful accounts is set up to anticipate the amount of bad debts from credit purchases.

 

Additional Resources

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