A discount is a reduction in the normal price charged for goods or services. There are a number of different types of discount but the main three are, bulk discounts, trade discounts and prompt payment (or early settlement) discounts.
A bulk discount is where a lower price is offered when the quantity of goods or services sold reaches a particular level. For example, a business might normally charge £10 per unit for a product but if a customer orders 1,000 units or more the business might reduce this to £8 per unit.
Bulk discounts are offered in order to encourage customers to buy larger quantities.
How should a bulk discount be recorded?
Bulk discounts should be taken into account when a business prepares an invoice for its customers. The total net, VAT and gross amounts on the invoice should be after the discount has been applied.
For example, let’s say a business sells 200 items that are priced at £50 each but applies a bulk discount of 20% where more than 100 items are sold. The total net, VAT and gross figures to be recorded on the invoice will be as shown in the table below:
|Total net before bulk discount (200 x 50)||10,000|
|Less bulk discount (10,000 x 20%)||-2,000|
|Total net (10,000 – 2,000)||8,000|
|VAT @ 20% (8,000 x 20%)||1,600|
|Gross total (8,000 + 1,600)||9,600|
A trade discount is where a lower price is offered to customers who are in business themselves. For example, a builder’s merchants might offer lower prices to builders, plumbers and roofers than they would to the general public.
Trade discounts are offered to encourage customers that are likely to buy goods/services regularly to buy from the business.
How should a trade discount be recorded?
Like bulk discounts, trade discounts should be taken into account when a business prepares its invoices and the total net, VAT and gross amounts should be after the trade discount is included.
For example, let’s say a business sells goods priced at £5,000 to a customer that qualifies for a trade discount of 15%. The total net, VAT and gross figures to be recorded on the invoice will be as shown in the table below:
|Total net before trade discount||5,000|
|Less trade discount (5,000 x 15%)||-750|
|Total net (5,000 – 750)||4,250|
|VAT @ 20% (4,250 x 20%)||850|
|Gross total (4,250 + 850)||5,100|
Note that the above types of discounts are not mutually exclusive, so a business might qualify for both a trade and a bulk discount.
Prompt payment discounts (also known as early settlement discounts)
A prompt payment discount is a reduction in the amount to be paid by a customer because the customer has paid earlier than they had to. It is therefore only available to credit customers (i.e. those customers who are allowed a period of credit before they pay the supplier). For example, a business might allow a customer to pay 30 days after an invoice is issued but might offer a prompt payment discount of, say 2%, if payment is made within 7 days of the invoice.
Prompt payment discounts are offered to encourage customers to pay more quickly (which should improve the business’ cash or bank balance).
How should a prompt payment discount be recorded?
Unlike bulk or trade discounts, a business does not know whether or not a credit customer will qualify for the prompt payment discount when it prepares its sales invoice. As a result, the business does not take this type of discount into account when calculating the total net, VAT and gross figures charged on its invoices. So how should a business record the discount?
Businesses have two options which are covered below. Please note that the Option 2 is not currently examinable by the AAT in their assessments.
When a business receives a payment from a customer that qualifies for a prompt payment discount, the business will issue a credit note for the discount. The gross amount on the credit note will be the difference between the gross amount on the paid invoice and the amount to be paid after the prompt payment discount is taken into account. The VAT on the credit note will be 1/6th of the gross amount on the credit note and the net amount on the credit note will be the difference between the gross and VAT amounts.
For example, let’s say that a business invoices a customer £6,000 and offers a 1% prompt payment discount for payment within 10 days. The customer then pays within this 10 day period and takes up the discount when making the payment.
The customer will therefore pay £6,000 less 1% of £6,000; i.e. £5,940 (a reduction of £60). The supplier will then issue a credit note which includes the following amounts:
- Gross amount on the credit note (£6,000 – £5,940): £60
- VAT on the credit note (£60 x 1/6): £10
- Net prompt payment discount (£60 – £10): £50
The credit note itself will include all the usual information required on other types of credit note (though many businesses will use a different numbering system for these types of credit notes).
Alternatively, a business may avoid issuing credit notes for prompt payment discounts by including an appropriate statement on all its relevant invoices. The statement must explain the basic terms of the discount and go on to say that where a prompt payment discount is taken up by a customer, the customer must only recover the VAT actually paid. An example is recorded below:
Businesses that decide to use this route may also include information about the amounts charged after the prompt payment discount. This is not strictly required but can help customers ensure that they claim the correct amount of VAT. An example is shown below: