Journal entries for cash discounts
A cash discount rewards early payment. Because the price falls, the VAT has to be corrected as well, which makes discounts a classic exam topic.
How to book it
- 1
The discount is calculated on the gross amount and split into the net discount and the VAT correction.
- 2
We pay with a discount: debit Trade payables (full amount), credit Bank (amount paid), Discounts received (net) and Input VAT (correction).
- 3
A customer pays with a discount: debit Bank (amount received), Discounts allowed (net) and Output VAT (correction), credit Trade receivables (full amount).
Worked examples
We pay the invoice from Smith Ltd for £18,000.00 (including 20% VAT) by bank transfer, deducting a 3% cash discount.
Correct journal entry
Trade payables £18,000.00 / Bank £17,460.00, Discounts received £450.00, Input VAT £90.00
Debit
Trade payables£18,000.00
Credit
Bank£17,460.00
Discounts received£450.00
Input VAT£90.00
Why?
- Trade payables: liability decreases → debit
- Bank: asset decreases → credit
- Discounts received: discount received reduces the cost of goods → credit
- Input VAT: asset decreases → credit
Calculation
- Gross discount: 3% of £18,000.00 = £540.00
- of which £450.00 net and £90.00 VAT correction (input VAT goes down)
- Transfer: £18,000.00 − £540.00 = £17,460.00
Green Retail Ltd pays our invoice of £3,600.00 (including 20% VAT) by bank transfer and deducts a 2% cash discount.
Correct journal entry
Bank £3,528.00, Discounts allowed £60.00, Output VAT £12.00 / Trade receivables £3,600.00
Debit
Bank£3,528.00
Discounts allowed£60.00
Output VAT£12.00
Credit
Trade receivables£3,600.00
Why?
- Bank: asset increases → debit
- Discounts allowed: discount allowed reduces sales → debit
- Output VAT: liability decreases → debit
- Trade receivables: asset decreases → credit
Calculation
- Gross discount: 2% of £3,600.00 = £72.00
- of which £60.00 net and £12.00 VAT correction (output VAT goes down)
- Received: £3,600.00 − £72.00 = £3,528.00
Your turn
Choose the accounts, enter the amounts and check. Amounts work with or without separators, e.g. 2,400.00 or 2400.
Transaction
Green Retail Ltd returns goods worth £1,300.00 plus 20% VAT. We issue a credit note.
Debit
Assets up · expenses · liabilities down
Total debit£0.00
Credit
Liabilities up · income · assets down
Total credit£0.00
All cases on this topic
Typical mistakes
- Clearing only the amount paid from payables: the whole debt is settled, so the full invoice amount.
- Forgetting the VAT correction: input or output VAT would no longer be right.
Frequently asked questions
How is a cash discount with VAT calculated?
Gross discount = percentage of the invoice amount. Divide by 1.2 for the net part; the rest is the VAT correction. Example: 2% of £2,400 = £48, of which £40 net and £8 VAT.
Why is input VAT credited?
The purchase price went down, so the VAT you can reclaim goes down too. An asset decreases on the credit side.
Is a discount received income?
It reduces the cost of goods. Many charts of accounts keep it on its own account, Discounts received.