I love a bargain! A good buy in the sales because of a discount is very satisfying.
In business however discounts must be more than just satisfying as they can be a critical part of running an organisation profitably. Receiving discounts from suppliers helps to keep costs down and budgets on track. Allowing discounts to customers can incentivise sales and plays a part in maintaining solvency by encouraging the prompt payment of invoices.
This is the first article in a series in which we are going to look at discounts – what they are, how we calculate and show them on invoices, and how they are recorded in the accounting records.
Types of discounts
We need to know the difference between three types of discounts at AAT foundation level:
- Prompt payment (PPD)
Trade discount is a percentage of the list price of goods that is deduced from the net value of the goods, for certain customers. Trade discounts are given to customers for a number of reasons. It may be just because it is a business as opposed to a member of the public, or because the organisation is a frequent or loyal customer.
Bulk discount is also a percentage of the list price of goods that is deduced from the net value of the goods. However, unlike trade discount it is not reserved for specific customers but applied when any customer buys large quantities.
Prompt payment discount is different to the other two. It is a percentage of an invoice total that is deducted by the customer if the invoice is paid within a specific timescale. PPD is offered to customers to encourage them to pay invoices earlier than the standard terms that are in place. However, some customers may choose not to take the discount opting for more time to settle debts instead.
Let’s imagine we are calculating the discount for a customer who is buying 3,000 units of a product which has a list price of £24.75 plus VAT per 15 units.
If we offer them a trade discount of 5%, the calculation is:
If we offer them a bulk discount of 1% per 1,000 units, the calculation is:
If we offer them a prompt payment discount of 3% if payment is received within 7 days of the invoice date, the calculation is:
You will notice that the discount is not included in the calculation for the invoice total. That is because unlike the trade and bulk discounts the PPD might not be deducted. Therefore the terms of the PPD (3% if payment is received within 7 days of the invoice date) are included on the invoice but the actual amount is not.
In part 2 we will look at how each type of discount is shown on an invoice, how those invoices are entered into the accounting records at the point they are sent to the customer and then how the accounts are updated once a payment is received.
Gill Myers is a self-employed accounts consultant. She has taught AAT qualifications since 2005 and written numerous articles and e-learning resources.