Trade discounts are given to customers for a variety of reasons. The main reason a trade discount is offered is to encourage customers to either purchase more goods over a period of time and/or to encourage them to place larger individual orders.
It is normal policy to show the percentage of trade discount on the face of a sales invoice. The customer pays the net price if sales tax is charged, it should be added to the net price, and the customer is required to pay the net price plus sales tax. Different percentages of trade discounter isy be applied to different products, in which case the relevant percentage discount is normally shown against each product on the invoice before sales tax is calculated, as in the following layout:
| Product | Description | Quantity | Item price | Discount | Total S |
|---|---|---|---|---|---|
| S | |||||
| HS336 | Table | 6 | 100.00 | 600.00 | |
| HS472 | Chair | 1 | 90.00 | 10% | 90.00 |
| 5% | 513.00 | ||||
| 603.00 | |||||
| Sales tax @ 20% | 120.60 | ||||
| 723.60 | |||||
Remember that trade discount is not recorded in the accounting records by either the seller or the customer.
A settlement (or prompt payment) discount is a discount that is offered to a customer if the invoice is paid by a specified date, prior to the end of the normal credit period.
Typically, an invoice will state that payment is due 30 days from the invoice date. However, to persuade the customer to pay early, a percentage discount will be offered if payment is made before the due date. This discount is known as a settlement discount or prompt payment discount.
A settlement discount is therefore different in nature to a trade discount. A trade discount is a definite reduction in price that is given to the customer. A settlement discount is a reduction in the overall invoice price that is offered to the customer. It is for the customer to decide whether to accept this discount and pay the reduced amount within the required timescale, or whether to pay the full invoice amount at some later date.
In practical terms if a settlement discount is offered to a credit customer, there is no way of knowing, at the point when the invoice is prepared, whether the customer will take advantage of the discount terms offered and pay the reduced amount. This is known as 'variable consideration' as the seller does not know at the time sales revenue is recorded whether they will receive only the discounted amount or the full amount. A business could therefore adopt one of the following approaches to deal with this situation:
Therefore, in examination questions, it will be stated whether a credit customer is expected to take advantage of settlement discount terms or not for the purpose of calculating amounts due from customers, or to calculate and account for amounts received from customers.
For example, consider the situation of a business which sold goods to a customer at a price of $200, and the customer is offered 3% settlement discount for settlement within ten days of the invoice date.
If the customer is expected to take advantage of the early settlement discount terms, the invoice would consist of the following amounts:
| List price | S | 200.00 |
| Less: 3% settlement discount | (6.00) | |
| Amount due from customer | 194.00 |
In this situation, settlement discount allowed is excluded from the accounting records in the same way as trade discount is excluded from the accounting records. The accounting entries initially recorded by the seller would be as follows:
| Debit | Credit | |
|---|---|---|
| Receivables $194.00 | $194.00 | |
| Revenue $194.00 | $194.00 |
Subsequently if, as expected, the customer pays within ten days to take advantage of the early settlement terms, the receipt of cash will be accounted for as follows:
| Debit | Credit | |
|---|---|---|
| Cash $194.00 | $194.00 | |
| Receivables $194.00 | $194.00 |
If the customer does not take advantage of the early settlement terms, the full amount of $200.00 is due. When it is received, the additional variable consideration received is accounted for as if it were an additional cash sale as follows:
| Debit | Credit | |
|---|---|---|
| Cash $200.00 | $200.00 | |
| Receivables $194.00 | $194.00 | |
| Revenue $6.00 | $6.00 |
If necessary, refer back to chapter 4 which provides further detail and explanation of trade and settlement discounts.
1 What may appear on an invoice to indicate that delivery is not included?
A E & OE
B Ex works
C 30 days net
D Settlement discount
2 Why are sales invoices prepared in multiple copies?
(1) To update the accounting records
(ii) To file for reference in case of customer query
(iii) For record keeping purposes in the business
(iv) For sending to the customer
A (i), (ii) and (iii)
B (i), (iii) and (iv)
C (ii), (iii) and (iv)
D All the above
3 How does a customer know to which transaction a credit note relates?
A By reference to the credit note number
B By reference to the amount of the credit note
C By the reason given for the issue of the credit note
D By reference to the quoted invoice number on the credit note
4 Three office chairs costing $77 each with an agreed trade discount of 10% have been delivered to a customer. What is the total of the invoice for the three chairs?
A $7.70
B $69.30
C $207.90
D $210.00
5 A sale was made to a credit customer at a price of $500, less trade discount of 5%. The customer is expected to take advantage of the early settlement discount terms and receive 4% discount for payment within ten days. What is the total of the sales invoice?
A $456.00
B $475.00
C $480.00
D $495.00
6 A sale was made to a customer at a price of $750. The customer is entitled to 6% trade discount. Early settlement discount of 2% has been offered to the customer for payment within ten days, but the customer is not expected to take advantage of this offer. What is the total of the sales invoice?
A $690.90
B $705.00
C $735.00
D $750.00
7 A sale was made to a customer at a price of $1,500. The customer is entitled to 6% trade discount. Early settlement discount of 3% was offered to the customer for payment within ten days, and the customer was expected to take advantage of this offer. Subsequently, the customer did not take advantage of the early settlement discount and paid after 30 days. What accounting entries are required to record the subsequent receipt of cash?
A Debit Cash $1,410.00 Credit Receivables $1,410.00
B Debit Cash $1,367.70 Credit Receivables $1,367.70
C Debit Cash $1,410.00 Credit Receivables $1,367.70 Credit Revenue $42.30
D Debit Cash $1,367.70 Credit Revenue $1,367.70
8 Abacus made a sale to a credit customer at a price of $600, less trade discount of 10%. The customer is expected to take advantage of the early settlement discount terms and receive 4% discount for payment within ten days. What accounting entries should Abacus make to record this sale?
A Debit Receivables $540.00 Credit Sales $540.00
B Debit Receivables $518.40 Credit Sales $518.40
C Debit Receivables $576.00 Credit Sales $576.00
D Debit Receivables $516.00 Credit Sales $516
9 Aardvark made a sale to a customer at a price of $1,500. The customer is entitled to 6% trade discount. Early settlement discount of 2% has been offered to the customer for payment within ten days, but the customer is not expected to take advantage of this offer. What accounting entries should Aardvark make to record this sale?
A Debit Receivables $1,380 Credit Sales $1,380
B Debit Receivables $1,410 Credit Sales $1,410
C Debit Receivables $1,500 Credit Sales $1,500
D Debit Receivables $1,470 Credit Sales $1,470
For a suggested answer, see the 'Answers' section at the end of the book.