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Settlement Discount

Hiya everyone,

Just wondering if anyone has any tips on how to remember settlement discount easier?

Just trying to get my head around it & it's still confusing me. Sometimes how the questions are worded as well really confuse me easily.

Thank you in advance!
AAT Level 3 :)


  • ariadneariadne Registered Posts: 218
    Is it the invoice calculation bit or the accounting for it part?

    Invoice bit, the rule is VAT is calculated as if the discount is taken and no adjustment is made even if it isn't taken. The total for the items, without VAT, is the full amount, after any trade/bulk discounts are taken but don't deduct settlement discount. This is done later in the accounts.

    Accounting, I always remembered Discounts Allowed go on the Debit side of the Discounts Allowed account. Not sure why but this meant I could work the rest out from there. Discounts allowed are always related to receivables, you've allowed it for the customer.

    Discount Allowed -

    D Discount Allowed
    C Receivables (this reduces the amount owed by the customer as the full invoice total is on the D side)

    So the reverse works for discount received from your supplier, you are receiving the discount -

    D Payables (again this reduces the amount you owe the supplier off the D side)
    C Discount Received
  • RosieCarlisleRosieCarlisle Greater ManchesterRegistered Posts: 60
    It confused me at first, but trust me, it will click eventually!

    Basically when you create the initial invoice and work out the price, you're doing everything as normal except that the VAT is worked out AS IF the discount had already been removed (but it hasn't). When you create the initial invoice, the only thing that's adjusted is the VAT amount (worked out by deducting the discount from NET figure, but NOT changing NET figure on invoice).

    Then if the person pays within the time allowed for the discount (say 10 days), then you remove the discount (say 5%) from the total amount, but worked out from the NET amount. So you're effectively working with the settlement discount twice (if they pay in time).

    So for example, say this was the initial invoice, with 5% settlement discount offered:

    NET total: £500
    VAT: £95 (worked out by deducting 5% from £500, which is £475, and then calculating VAT from that figure)
    Overall total: £595 (NET plus reduced VAT)

    If the person doesn't pay in time, they'll pay £595 as mentioned above. If they DO pay in time, however, we again work out 5% of £500, which is £25, so this is their discount. They've qualified for it, so we deduct £25 from the overall total of £595, which is £570. That's what they'll pay.

    An important thing to remember (which I kept forgetting at first) is to always work out the settlement discount from the NET amount, not the overall total after VAT.

    I hope this was even slightly helpful! I've only been learning it myself a few weeks, so if anyone spots anything I haven't got quite right, please feel free to correct me. ;)
  • amy256amy256 Registered Posts: 32
    edited October 2014
    Thank you for your help!
    AAT Level 3 :)
  • amy256amy256 Registered Posts: 32
    I'm using the Bookkeeping 1 workbook from Osbourne books and I am on chapter 2, question 2. For 2.1, it states that the list price of goods is £4.00 per box file plus VAT @ 20% & that a trade discount of 20% and a settlement discount of 2% is to be offered for payment within 14 days.

    I have therefore worked out that £4.00 x 100 = £400.00.
    Then, applied the trade discount: £400.00 x 20/100 = £80.00, which leads to a net price of £320.00.
    Next, I calculated the settlement discount so this is £320.00 x 2/100 = £6.40, so the reduced goods value (which doesn't go on the invoice, right?) is £313.60.
    Then, I calculated the VAT on this amount which is £313.60 x 20/100 = £62.72.
    Finally, I used the total invoice price BEFORE the deduction of settlement discount to get £320.00 (net) + £62.72 (VAT) = £382.72 (gross invoice total).

    Assuming that is all correct, it's the next part of the question that throws me that I am struggling to understand. Please help! :pensive:
    It goes on to say:
    "If Dover Designs does not settle the invoice within 14 days, Dover Designs will have to pay Praxis Stationery a total of:
    a) £382.72
    b) £376.32
    c) £384.00"

    Apparently the correct answer is A, but I got C. I really don't follow, presumably if they are NOT settling the invoice in the selected time period, then they DON'T receive the settlement discount, so why is the VAT still adjusted for this?

    Thanks in advance for your help!

    AAT Level 3 :)
  • RosieCarlisleRosieCarlisle Greater ManchesterRegistered Posts: 60

    Yep, everything before the bold text is completely right! :)

    So the £382.72 you worked out is what the customer will always pay if they DON'T pay within the allotted time. If they did pay in the allotted time, you'd take off the £6.40 that you worked out earlier from the NET amount.

    It's irrelevant whether the customer pays within the time, the VAT is always adjusted, and then not changed. In all honesty I'm not sure why that is - I think it's something to do with not overcharging VAT.

    So you'll always do the calculation you explained, and then you'll either:

    1) Leave it as £382.72. This is if the customer pays outside the allotted time.


    2) Remove the £6.40 you worked out earlier, which comes to £376.32. This is what they'll pay if they settle the invoice within the time allowed.

    Basically, once you've created the invoice, it's NEVER increased. The only adjustment you would make is reducing the amount further, as mentioned in 2) above.
  • CeeJaySixCeeJaySix Well-Known Registered Posts: 645
    Rosie has it spot on for your studies. However from a practical perspective you may be interested in this: https://www.gov.uk/government/publications/vat-prompt-payment-discounts

    Essentially from next April HMRC are (finally) taking your logic Amy, and VAT will be calculated based on the amount actually paid. For now just stick with the above!
  • RosieCarlisleRosieCarlisle Greater ManchesterRegistered Posts: 60
    Oh interesting! Haha, just as we've learnt it the other way. :)
  • RonaldRonald Registered Posts: 1
    Does anybody know what AAT / Exam providers are going to do from next April on this subject?
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