Unearned Discounts

Cash discount payment terms

If you offer cash discount payment terms, chances are you have an issue with a number of customers who take the discount when in fact they have paid beyond the discount date. Under the best of circumstances this can be a difficult issue to deal with. I’ll outline one strategy that many of my clients have found helpful:

1. Don’t try to collect unearned discounts that aren’t worth the effort, or that you have no hope of collecting because of the customer relationship. Simply write-off unearned discounts that are too small to worry about and any discounts from those customers that you know will never pay them. If you have a capable AR system, this should be relatively easy to do utilizing the system’s automatic discount handling and write-off tolerancing.

2. Consider adding a grace days period to your discount cut-off date. Three to five days is typical.

3. For customers with a few large invoices, it’s fine to continue with what I assume is your normal short-pay procedure: short pay the invoice or create a chargeback for the unearned discount to the customer.

4. Large customers with many small invoices are usually the biggest challenge. The small invoices can creep in just under your write-off tolerance, yet still add up to a significant amount that you really shouldn’t accept. And even when they’re over tolerance the sheer volume can clutter up your open AR and prove difficult to manage. My recommendation here is to “write-off” all these amounts to an unearned discount reserve GL account. This will remove the clutter from your normal open AR and segregate them for subsequent collection efforts.

5. Periodically, usually quarterly, summarize the activity in your unearned discount reserve account and send a dispute package to the customer. Be sure to include the detailed invoice-by-invoice detail of the unearned discount. You might be surprised how some customers react. You’re unlikely to collect the full amount, but it’s rare in my experience that you won’t be able to get a partial settlement. And, now that they know you’re watching and keeping detailed records, the frequency of the offense might drop as well.

Automate discount handling

The degree of effort to implement such a strategy depends on the capability of your AR system. Modern, well equipped systems have special logic to automate discount handling and the ability to control tolerances by reason code and customer, plus the reporting facilities to easily generate the invoice detail required.