9. Summary of discussion on while the merchant must charge each customer $124.74 if he sells on 60 days' time, which is $120 for the goods, $1 for interest, $1.22 for credit insurance and $2.52 for the expense of the credit and collection depart ment, he can easily afford to offer each customer the $1 for interest and the $1.22 for credit insurance or $2.22 as a, discount if the customer will pay cash. This amounts to 1.78 per cent of the invoice value and probably the merchant should make it an even 2 per cent in his offer, for if he offers to sell on credit, he must maintain a credit department and col lection machinery at considerable expense.
It is evident, then, that the customer who pays cash, pays for his own goods and a share of the credit and collection department expenses caused by the credit system. The customer who does not take the prof fered cash discount, not only pays for the goods and for the total surcharge of the credit system, but he also pays for interest on the investment in his own account, besides making a contribution on the goods purchased by the defaulters, including interest on their tion. If the customer does not take the cash discount, the additional amount which he pays at the maturity of his account is not paid for his own goods at all and, therefore, is not a part of the cost of these goods.
Cash prices are present prices. Credit prices, on the other hand, are future prices and contain allow ances for interest and credit insurance. If a person has not sufficient funds of his own to pay cash and take his discounts, he will find it more economical, providing he has sufficient credit at his bank, to bor row funds with which to obtain this discount. In this way he will save not only a part of the payment he otherwise would make to cover interest on the pur chase cost, but also his entire contribution to the risk fund. Indeed, the function of commercial banks is precisely that of financing such transactions.
10. Records of these transactions.—From the fore going illustration, it is evident that of the $124,742.27 charged by the merchant to the customers at the time of the sale, $2,494.85 is offered as a discount for cash at the rate of 2 per cent. The merchant would be justified in making the entry on his books as follows: The debit to accounts receivable represents the full contractual right which the merchant has against these customers if they take the time allowed. The credit
to discount on sales represents the counter right to the discount offered them. During the ten day period during which the discount offer remains open, this credit may be viewed as a contingent liability, offset ting an equal amount of contingency in the charge re corded against the customers. The credit to the sales account represents the cash value of the goods under a credit system. The fact that the $2,494.85 credited to discount on sales is equivalent to the amount which was previously figured as the expense of the credit and collection department is a mere coincidence. This is due to the fact that it is assumed in one case, that the credit and collection expense equal 2 per cent of the invoice value, and, in the other that 2 per cent is chosen as the discount allowance instead of the awk ward 1.78 per cent which is, theoretically, the correct amount.
This method of recording purchases of such a na ture is not yet accepted as the standard practice by accountants. We can only hope that, as time goes on, the business men will come to realize the inaccuracy of their present method of recording credit sales or pur chases.
11. The common method.—As opposed to this the oretically correct method of recording discounts on sales or purchases, we find that the average business man puts them on his books only after they have been taken. In recording purchases from others no ac counting record is made of the proffered discount. When the bill is paid and discount taken, discount gained account is credited thru the cash book. This account becomes a credit account which is interpreted as a source of income, instead of as a reduction in the cost of the goods themselves.
In the case of sales, the common method is to credit the sales account with the invoiced value of the goods and to make no entry representing the discount offered the customer. If the customer takes this discount, "discount lost" is debited thru the cash book as already described, and this ac count shows a debit balance which is interpreted as loss. It may be asked that if discounts are actual losses why should they be offered? The theory on which they are recorded as an expense is : first, to show the reduction in sales due to discounts which are taken; secondly, to show the results of that phase of our finan cial transactions, and thirdly, because they are an in vestment designed to reduce the total loss from bad debts.