2. Net Sales

Let's talk about net sales. Right away, this word net should clue you into something. If you'll remember, we had something like gross income back when we were talking about the income statement, gross income, a bunch of stuff, net income.

And this net right here is this same net right here. So you can see that accounting kind of builds on itself. So when you see stuff that you don't really understand, see if you can think it through and apply any of the other accounting principles to what you're trying to figure out. So let's do that now. We've got net sales that we don't really know what it is, and we've got this net income model. Well, there's a gross at the top, so let's take gross sales and net sales.

So right away we know, okay, well, something goes at the top, then we're gonna take out a bunch of stuff, maybe even add some stuff, and then we'll end up with net sales. So when you see net sales on your test, immediately, you should think net. That's the bottom. Okay. So that's after whatever this stuff is has come out. Now let's talk about this stuff.

There are a couple of things that you're gonna take out of gross sales. Just let's start at the top by saying sales revenue is $1,000. Okay, so this is the very top line. This is gross sales revenue. So sales revenue is just gross sales up here.

This is before you take any of that stuff out. Now let's think logically. If we sold $1,000 of stuff, what could come out of that such that we end up with some smaller number down here for net sales? Well, me as a consumer, sometimes I return things, so that would definitely be one thing. The way that you typically see this set up is you see less sales R&A, and you'll see an amount over here.

R&A. R&A stands for returns and allowances. So if you return something, it goes into the sales R&A account. Now this allowances, this basically just means store credit. So sales R&A should not be a foreign concept to you. As a consumer, you return things and get cash, or you get store credits, you get allowances for the next time you come shopping.

So that's one thing that could be taken out of sales revenue. The other is something called, not surprisingly, discounts. And then you put that over there, and then you end up with your net sales down at the bottom. Let's talk about these discounts, though. A lot of big companies, especially when dealing with businesses, will have something called credit terms, meaning that you can buy from them and not pay for, you know, 10 or 30 days. But because companies love money and they love getting money fast, you'll see credit terms expressed as something like this: 1/10, n/30. And that means a whole lot of nothing right now.

But if we expand it a little bit, 1% 10 days or net 30 days, that still doesn't mean very much, but we're getting close. So what we have here is this is the pay early discount.

This is the regular term. So what this is telling you is that you have 30 days to pay the net, to pay the full amount, net of returns and allowances, basically. But if you pay in 10 days, you can take 1% off of your bill. And companies will do this because they want to get paid quickly, and they think it's worth taking a 1% hit to get paid quickly. And there's a whole... We'll do a whole 'nother video on whether or not to take the discount. You can actually come up with a single number about whether or not you should take the discount or wait and pay after 30 days.

But should a company take this 1% discount? And you could also see, I mean, you could see 2/10, n/45. You could see 1/15, n/45. You could see any number of things. Just remember, this is the percentage, these are the days, and this just means net. This just means all of it. So should a company decide we're gonna pay within 10 days so that we can get 1% off, that's where you end up with sales discounts. You still record the full amount of revenue, but you also record a discount.

That may not make a lot of sense. Let's look at a journal entry because we love journal entries. We made a sale for, let's just call it $1,000 on 2/10, n/30. And the people we sold it to took the discount.

So we made a sale for $1,000 on 2/10, n/30 terms. They took the discount. So right away, what you need to be thinking is, "Oh, they got 2% off." So if they got 2% off, we did not get $1,000. What we did get is 98% of $1,000, or $980. So when you go to do the journal entry, you may be tempted to do this: cash, 980; sales revenue, 980. That would get you zero points on the test, and that's the problem, because this is right, but this is not right.

Because we have this account here, we put the discounts into this account. Now, here's where it gets fun. That discount account is a contra revenue. And if you'll remember from one of the earlier chapters, from one of the things that was on your first test, contra accounts are just opposite accounts. So let's try this again. Cash, 980, and I told you we need to record the sales revenue at the full amount. So then we have this contra revenue called discounts. Now we sum to $1,000 and we equal at $1,000. So discounts is a contra revenue in the same way that returns and allowances are a contra revenue.

So sales R&A and discounts only serve to take away from revenue. They are contra revenue accounts, not assets, not liabilities, not expenses even, contra revenue. All right, let's look at it again quickly. You see net sales. You remember from this pattern, you recognize the net and gross pattern. So you set this pattern up in your mind. Well, net means there's a gross and there's something in the middle. The gross is just the top line. We just say, what is our total revenue? And then we take out any returns and allowances we gave and any discounts that we gave. And the reason that we keep these separate is for basically accountability, so we can see how many returns and allowances are we giving?

How many sales discounts are we giving? 'Cause if we lumped it all into this number, we would have no idea. But we break these out separately so that we can have visibility into them. These two accounts are contra revenue. Their only purpose is to take away from sales revenue. They're not even expenses. They just reduce revenue.

So you start with your gross, you take out some stuff, and you end up with your net. Now, to calculate those discounts, you need to remember this pattern, 1/10, n/30. And we expanded that to say 1% if you pay within 10 days or net if you pay within 30 days. So this is your pay early discount versus basically your contract, what you actually have to do if you don't pay early. And then we worked through a problem down here and said, "Do not record the reduced amount for revenue." It's correct for cash, but for revenue it's very, very wrong. Record the full amount of revenue, and then also in this contra account, record the discount.

Same goes for sales returns and allowances. And like I mentioned, we'll have another video on just the question, should you take the discount?