Receipts, discounts, and bad debts - Prompt-payment discount...

Learning Outcomes

After reading this article, you will be able to record receipts from customers, distinguish between trade discounts and settlement (prompt-payment) discounts, account for discounts allowed and received, and explain the accounting treatment for irrecoverable debts (bad debts). You will apply this understanding to produce accurate ledger entries and avoid common mistakes when dealing with customer payments, discounts, and uncollectible amounts.

ACCA Recording Financial Transactions (FA1) Syllabus

For ACCA Recording Financial Transactions (FA1), you are required to understand the principles and processes involved in handling receipts, discounts, and irrecoverable debts. In particular, focus your revision on:

• Distinguishing between trade discounts and settlement (prompt-payment) discounts and their treatment in the accounting records
• Recording receipts from customers, including cases where settlement discounts are allowed
• Calculating and accounting for discounts received from suppliers for early payment
• Understanding the double-entry for irrecoverable (bad) debts
• Preparing relevant ledger entries for receipts, discounts, and bad debts

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. A credit customer is offered a 2% discount if they pay within 10 days. They settle a $1,000 invoice on day 8. What amount should they pay, and how is the discount recorded?

2. Which discount is shown on the invoice and not recorded in the accounting ledger?
   1. Trade discount
   2. Settlement discount
   3. Cash discount
   4. Bulk discount

3. True or false? If a customer pays after the prompt-payment (settlement) discount period, the full invoice amount becomes due.

4. Briefly explain the accounting entries required when a trade receivable is written off as an irrecoverable (bad) debt.

Introduction

Businesses often allow customers extra time to pay for goods or services. To encourage quick payment, sellers may offer a "prompt-payment" or "settlement" discount, rewarding customers who pay early. It is essential to understand how and when to record these discounts, both when you allow a discount to your customers and when you receive a discount from a supplier. This also links closely to the treatment of customer debts that are unlikely to be collected.

This article will help you distinguish between different types of discounts, show you how to record receipts taking discounts into account, and explain the correct way to handle bad debts when they occur.

Key Term: Trade Discount
A reduction from the list price of goods, usually offered to regular or bulk-buying customers, shown on the invoice but not entered in the accounting records.

Key Term: Settlement (Prompt-payment) Discount
A discount offered to customers for paying their invoice within a specified period, recorded in the accounting records only if taken up.

RECEIPTS AND PAYMENT TIMING

When a business makes a credit sale, an invoice is issued. The customer is given a set period—known as "credit terms"—in which to pay. Sometimes, the invoice includes an offer of a prompt-payment discount if settled early.

Recording Receipts

• If a customer pays the full amount outside the discount period, the payment received equals the amount invoiced.
• If the customer pays within the discount period and deducts the settlement discount, only the reduced amount is received. Both the cash receipt and the discount allowed (if you're the seller) must be recognised.

Key Term: Receipts
Cash, cheque, or electronic payments received from customers as settlement of invoices, recorded according to the amount received.

TYPES OF DISCOUNT: WHAT TO RECORD

Not all discounts work the same way in the accounts.

Trade Discounts

Trade discounts are deducted from the price at the time of sale. The net (discounted) price is shown on the invoice. Only the discounted price is recorded—never the trade discount amount itself. Trade discounts are not tracked in the ledger.

Settlement (Prompt-payment) Discounts

Settlement discounts are offered as an incentive for prompt payment—e.g., "2% if paid within 14 days; otherwise net 30 days." Whether the discount is taken depends on how quickly the customer pays.

If the customer pays in time and claims the discount:

• The seller receives less than the invoice's total.
• The difference is recognised as "discount allowed" (an expense).

If payment is late, the seller receives the full invoice total and no discount is recognised.

Worked Example 1.1

A company issues a $1,200 invoice to a customer, with terms "3% discount if paid within 7 days." The customer pays $1,164 on day 6. Show the accounting entries for the seller.

Answer:

• Debit: Cash at bank $1,164
• Debit: Discount allowed $36
• Credit: Receivables $1,200

This clears the receivable (amount due from the customer).

Worked Example 1.2

A supplier issues an invoice for $800, terms: "2% discount if paid within 10 days." You pay on day 9.

Answer:

• Debit: Payables $800
• Credit: Bank $784
• Credit: Discount received $16

The payment and discount reduce the total amount you owe.

Exam Warning

Be sure not to record trade discounts in the accounting system—record only the price after discount. Only settlement (prompt-payment) discounts that are actually taken should be entered in the records.

BAD DEBTS (IRRECOVERABLE DEBTS)

Sometimes, despite chasing, a customer fails to pay what is owed. If the balance is considered uncollectible, it should be written off.

Key Term: Irrecoverable (Bad) Debt
An amount owed by a customer that is judged as unlikely ever to be collected and is removed from the books as an expense.

Writing off a bad debt reduces assets (trade receivables) and increases expenses (bad debt expense).

Worked Example 1.3

A customer's balance of $420 is considered irrecoverable. Show the accounting entries.

Answer:

• Debit: Irrecoverable debts expense $420
• Credit: Receivables $420

This removes the balance from trade receivables and records the loss as an expense.

ACCOUNTING FOR RECEIPTS WITH DISCOUNTS

For Sellers: Discount Allowed

When you allow a prompt-payment discount to a customer and they take it:

• Debit: Cash at bank (amount received)
• Debit: Discount allowed (the discount)
• Credit: Receivables (full invoice amount)

If the discount is not used, simply:

• Debit: Cash at bank (full amount received)
• Credit: Receivables (same amount)

For Buyers: Discount Received

When you settle an invoice early and deduct the offered discount:

• Debit: Payables (invoice amount)
• Credit: Cash at bank (amount paid)
• Credit: Discount received (the discount)

If you do not pay in time:

• Debit: Payables (full amount)
• Credit: Cash at bank (full payment)

SUMMARY

• Trade discounts are deducted before recording, never shown in accounts.
• Only settlement discounts taken up are recorded in the accounts.
• Discount allowed is an expense for the seller; discount received is income for the buyer.
• Irrecoverable (bad) debts must be written off as soon as it is clear they will not be paid.
• Receipts should always be reconciled with invoices and discount terms.

Key Point Checklist

This article has covered the following key knowledge points:

• Identify and distinguish trade discounts and settlement (prompt-payment) discounts
• Record receipts from customers, with and without settlement discounts
• Prepare accounting entries for discount allowed (seller) and discount received (buyer)
• Explain and record the write-off of irrecoverable (bad) debts

Key Terms and Concepts

• Trade Discount
• Settlement (Prompt-payment) Discount
• Receipts
• Irrecoverable (Bad) Debt