Accounting Treatment of Trade & Settlement Discounts

Accounting Treatment of Trade & Settlement...

Didn't find your answer?

Dear All,

I'm seeking simple advice on the accounting treatment of discounts within the Accounts Payable function:

There are two kinds of discount available when paying invoices, namely:

(1) Trade Discounts which typically relate to bulk purchasing and
(2) Settlement Discounts which are taken when invoices are paid early

I would be grateful if someone could point me towards an appropriate resource to advise me on the accounting treatment of the above, especially the impact it has on VAT?

Many thanks in advance,

Ash

Ash Sharma

Replies (6)

Please login or register to join the discussion.

Routemaster image
By tom123
28th Jul 2004 15:41

Common in domestic fuel sales
One of our group companies sells heating oil to domestic customers from delivery lorries. It is industry standard to offer domestic customers a 2 pence per litre discount for settlement within 7 days.

Because of the specialist nature viz a viz large volume of transactions where you do not know before delivering how much fuel will fit in the tanks, the firm uses a sales ledger product tailored to fuel sales.

Our local newspaper does not show settlement discounts, but rather credit surcharges.

We never get the invoices paid in time, but tend to take the discount anyway.

Thanks (0)
avatar
By David Carter
26th Jul 2004 11:17

Are settlement discounts dying out?
Am I correct in thinking that settlement discounts are dying out? Most systems I install the users don't offer settlement discounts and only have the odd supplier who offers them.

It looks like most people who need early payment these days use factoring rather than settlement discounts

Thanks (0)
JPW
By jpwattam
28th Jul 2004 08:49

I think they're a waste of time...
I set up a settlement discount at a company I previously worked at. Despite stating the actual date for payment in order to qualify for discount, many customers seemed to take the discount regardless of when they paid. It was very irritating.

In the end I switched to a 'future discount' system, where each invoice would state that if we received payment by a specific date, a fixed percentage would be deducted from their next invoice. A few people still decided to deduct the discount from their current payment, which caused problems, but generally I found it worked better, and I was saved having to constantly explain why the VAT on a settlement discounted invoice appeared wrong.

From the other side, I currently have one supplier who offers a settlement discount. We can never process invoices in time to get the discount (which is a pathetic amount anyway) and frankly it's just an irritation having to over-ride the VAT calculation.

Further sideline: should we really be splitting settlement discounted invoices between the VATable and non-VATable (finance charge) element?

Thanks (0)
JPW
By jpwattam
20th Jul 2004 08:45

The difference
With a trade discount, the net of VAT total at the bottom of the invoice is after the discount, and VAT is therefore charged on that figure.

With a settlement discount, the net of VAT total at the bottom of the invoice is BEFORE the discount, but VAT is charged on the figure AFTER deducting the discount.

There is often confusion about the interaction of VAT with settlement discounts. Surely if the discount is not taken, then not enough VAT has been charged?

The thing to focus on is that a settlement discount is effectively a finance charge. What you are effectively saying to your customer is that if they pay within 10 days, they can pay only £90 plus VAT, so the total is £105.75. However, if they pay after 10 days they must also pay a £10 finance charge, and finance charges are VAT exempt.

What you actually write on the invoice is a net of VAT figure of £100, VAT of £15.75 and a gross total of £115.75, then put a note underneath saying "If paying by [date] please deduct £10 settlement discount" (or something similar).

The key factor is that finance charges are not VATable. I don't know the statutory reference offhand that states that settlement discounts fall into this category.

Thanks (0)
avatar
By AnonymousUser
20th Jul 2004 09:53

Thanks!
Many thanks indeed, your advice is very useful indeed.

Thanks (0)
avatar
By neileg
20th Jul 2004 10:01

I agree with Julian...
... except that not all suppliers follow these VAT rules with settlement discounts. You will often find that VAT is calculated on the invoice total after trade discounts but before settlement discounts. I don't have a technical explanation of this, it's just my observation over many years. Perhaps it stems from ignorance on the part of the supplier.

Thanks (0)