Cash discounts: calculating and recording them
A cash discount is a reduction for paying early. It is taken off the invoice total and the VAT on it is adjusted.
Updated
What is a cash discount?
Invoices often say “net 30 days, 2 % discount if paid within 10 days”. Paying early earns the discount. For the buyer it is a discount received, for the seller a discount allowed.
The discount lowers the price after the sale, so the VAT on the sale goes down too. In the UK the supplier usually issues a credit note when the discount is taken.
Before or after VAT?
The buyer pays the invoice total minus the discount. The discount itself contains VAT in proportion, which is the part the accounts adjust.
| Net | VAT 20 % | Gross | |
|---|---|---|---|
| Invoice | £1,000.00 | £200.00 | £1,200.00 |
| 2 % discount | £20.00 | £4.00 | £24.00 |
| Payment | £980.00 | £196.00 | £1,176.00 |
Journal entries
Discount received: Dr Trade payables 1,200 Cr Bank 1,176 / Discounts received 20 / VAT 4
Discount allowed: Dr Bank 1,176 / Discounts allowed 20 / VAT 4 Cr Trade receivables 1,200
Discounts received reduce the cost of purchases, discounts allowed reduce revenue. In many UK textbooks they are still shown as income and expense; check which version your course uses.
Check yourself
An invoice of £600 including 20 % VAT, 5 % discount. How much is paid?
More on accounting
Typical exam mistakes
- Not adjusting the VAT: a lower price means lower VAT.
- Taking the discount off the net amount but paying the gross amount minus that figure.
- Confusing a trade discount (on the invoice) with a cash discount (for paying early).
Your turn
Three transactions from the journal entry trainer: choose the accounts, enter the amounts and check.
Transaction
Bank statement: £7,800.00 paid to Hughes Trading for their invoice.
Debit
Assets up · expenses · liabilities down
Total debit£0.00
Credit
Liabilities up · income · assets down
Total credit£0.00
Frequently asked questions
Is a cash discount worth taking?+
Almost always. 2 % for paying 20 days early is roughly 36 % a year in interest terms, more than most overdrafts cost.