Sales and purchases day books - Trade discounts vs settlemen...

Learning Outcomes

After reading this article, you will be able to distinguish between trade discounts and settlement discounts in recording sales and purchases transactions. You will identify how each is treated in day books and the general ledger, apply correct accounting entries for both types of discounts, and avoid common exam errors.

ACCA Maintaining Financial Records (FA2) Syllabus

For ACCA Maintaining Financial Records (FA2), you are required to understand the recording and accounting treatment of various discounts within the sales and purchases cycle. Key syllabus points addressed include:

• Record sales and purchases, including returns, in the day books and general ledger
• Distinguish between trade discounts and settlement discounts
• Account for discounts allowed to customers or received from suppliers, including correct double-entry treatment
• Identify sources of information for discounts in day books and sales/purchase invoices
• Apply IFRS 15 requirements for revenue recognition, including the effect of discounts

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. Which type of discount is deducted directly on the invoice to arrive at the amount to be recorded in the sales or purchases day book?
   1. Settlement discount
   2. Purchase return
   3. Trade discount
   4. Sales tax

2. True or false? If a supplier offers a 3% discount for paying within 14 days, this discount is always recorded at the time the invoice is issued.

3. What are the correct double-entry postings when a settlement discount is taken up on payment of a purchase invoice?

4. Explain briefly why trade discounts are not shown separately in the general ledger.

Introduction

Day books are the initial records for credit sales and purchases transactions. Two common types of discount appear on sales and purchase invoices: trade discounts and settlement (prompt payment) discounts. These discounts are treated differently in the accounting records.

Understanding these differences is essential for accurately recording transactions, producing correct financial information, and answering ACCA FA2 exam questions.

Key Term: trade discount
A reduction in the catalogue or list price of goods, granted by the seller to certain customers (such as bulk buyers or regular clients), and deducted on the invoice before recording the transaction.

Key Term: settlement discount
A reduction in the invoiced amount offered by the seller for payment within a specified period. Also known as a prompt payment discount.

Recording Discounts in Day Books

How Trade Discounts Are Applied

When goods are sold or purchased, a trade discount (if offered) is immediately deducted from the list price on the invoice. Only the net amount after the trade discount is recorded in the sales or purchases day book and later posted to the general ledger.

• The trade discount is not recorded as a separate figure in the accounting system.
• The customer and supplier both enter only the net (discounted) value.

Example: If goods worth $1,000 are sold with a 15% trade discount, only $850 is entered in the sales day book.

How Settlement Discounts Are Treated

A settlement discount offers an incentive for early payment but is not guaranteed to be used. The treatment depends on whether the customer is expected to utilize the discount at the time of sale/payment.

At Invoice Stage

• The sales or purchases day book records the full invoice amount after trade discount but before any settlement discount.
• The settlement discount is disclosed on the invoice for information but does not affect initial recording.

At Payment Stage

• If payment is made within the discount period and the discount is taken:

  • Seller: Records cash received (reduced for discount) and recognizes the difference as a settlement discount allowed (reducing revenue).
  • Buyer: Records full liability to supplier; on payment, any reduction is recognized as settlement discount received (increasing income).

• If payment is not made within the period, the original invoice amount is paid and no further entry for discount is needed.

Worked Example 1.1

A business sells goods with a list price of $2,500 to a trade customer. It offers a 10% trade discount and a further 2% settlement discount for payment within 10 days. The customer pays the discounted amount within the discount period.

What amounts are recorded in the sales day book and what are the general ledger entries upon payment?

Answer:

• Sales day book: List price $2,500 less 10% trade discount = $2,250 (this is the amount recorded).
• At invoice:
  Debit Receivables $2,250
  Credit Revenue $2,250
• Upon prompt payment (within 10 days):
  Cash received: $2,250 × 98% = $2,205
  Settlement discount allowed: $45 ($2,250 - $2,205)
  Entries:
  Debit Cash $2,205
  Debit Settlement discount allowed $45
  Credit Receivables $2,250

Detailed Steps in the Accounting System

1. Recording in Day Books

• Trade discounts:
  Only the net value after trade discount is entered.
• Settlement discounts:
  The invoice is recorded at its net-of-trade-discount value; terms of settlement discount are noted, but no accounting entry occurs until payment.

2. Posting to General Ledger

• Sales and purchases are posted from the day books using the amounts post-trade-discount, pre-settlement-discount.
• When the settlement discount is actually taken, the ledger entries reflect the reduction from the original invoice.

Differences in Exam Context

It is critical to distinguish the stage at which each discount type affects the accounting records:

• Trade discounts: Always deducted before recording each transaction. Never entered as a separate item.
• Settlement discounts: Not recognized until payment is made (unless IFRS 15 requires estimating variable consideration, but in practice for most FA2 exam contexts, settlement discounts are recognized only if taken).

Accounting for Discounts Received from Suppliers

If an entity takes a settlement discount when paying a supplier:

• Debit Trade Payables (full gross amount)
• Credit Cash at bank (amount paid)
• Credit Discount received (income)

Worked Example 1.2

A business receives a purchase invoice for $1,000 with terms "2% discount if paid within 14 days." Payment is made within 14 days.

What are the correct entries on payment?

Answer:
Debit Trade Payables $1,000
Credit Cash at bank $980
Credit Discount received $20

Presentation in Integrated Sales and Purchases Cycles

• Trade discounts are applied before sales tax is calculated; settlement discounts do not affect the amount for sales tax in many tax jurisdictions.
• Only net-of-trade-discount amounts impact sales and purchases day book totals and the general ledger.

Key Differences Table

| Discount Type | When Deducted | Recorded Separately? | Recognized If Not Taken? |

|------------------|--------------------|----------------------|--------------------------|

| Trade Discount | On invoice | No | No |

| Settlement Discount| On payment (if taken)| Yes | No |

Worked Example 1.3

A supplier invoice shows a list price of $500 with a 10% trade discount and terms "4% discount if paid within 10 days." The business pays after 10 days.

What is recorded in the purchase day book, and what entry is made on payment?

Answer:

• Purchase day book: $500 - 10% = $450 (amount recorded).
• On payment (outside discount window):
  Debit Trade Payables $450
  Credit Cash at bank $450
  (No entry for settlement discount as none was taken.)

Exam Warning

ACCA FA2 exams often test whether you can distinguish when to account for each discount. Never record a trade discount separately. Only enter a settlement discount if actually taken up during payment. Double-check which amounts go into the day books and ledgers.

Summary

Understanding the distinct treatment of trade discounts (deducted upfront and never recorded separately) and settlement discounts (recognized only if taken upon payment) is fundamental for correct bookkeeping and accurate reporting. Day books and ledger entries must always reflect the proper amounts, and knowing when and how each discount affects accounting records avoids common errors.

Key Point Checklist

This article has covered the following key knowledge points:

• Explain the differences between trade discounts and settlement discounts
• Identify how each discount is treated in day books and ledgers
• Record settlement discounts correctly at the time of payment
• Know that trade discounts are never shown separately in accounts
• Apply correct double-entry for discounts allowed or received on payment

Key Terms and Concepts

• trade discount
• settlement discount