Page 10 Chapter 2

CHAPTER 2
Selling Goods and Services

Prompt Payment Discounts (PPD)

You may have noticed some payment terms we have not yet come across. A prompt
payment discount may be offered for early payment of an invoice. It encourages the
customer to pay sooner for the goods than the invoice allows. Under the ‘terms’ an entry
would be ‘A discount of 2% of the full price applies if payment is made within 7 days of the
invoice date.’. This would mean that 2% would be taken off if the customer settled the
invoice within the 7 days. Of course, the supplier may offer more or less than 2% and may
require more or less than 7 days.

The invoice on the previous page allows the customer 30 days to pay, but will be offered a
reduction of 2% if the invoice is paid within 7 days of the date of the invoice.

The problem with these kind of discounts is that the supplier has no idea whether the
discount will be taken or not until the customer actually pays (or the time limit of the
discount expires). It also makes it difficult where VAT is charged as the correct amount of
VAT must be recorded according to how much is paid.

When the invoice is issued the supplier will record the invoice in full although the invoice
must show the rate of discount offered. The supplier then has two options. They can issue a
credit note for the discount amount (including the VAT). A credit note is a refund document
stating that the customer no longer owes part or all of the amount on an invoice. We'll look
at a credit note later in this chapter. If this option is adopted then the credit note will be
kept as evidence of the discount.

The second option is that the original invoice must contain appropriate wording stating the
number of days by which the discount price may be paid, and a statement that the
customer can only recover the VAT paid to the supplier. (We will look at recovery of VAT in
the next chapter). If the customer pays later and doesn't take the discount then the supplier
will simply record the payment when it is made. However, if the customer does take the
discount the supplier will record the amount paid, the amount of the discount taken and
they must also adjust the VAT. (We will look at how to record all this in the business books
later in this book).

Of course, a prompt payment discount will be on top of any bulk or trade discount offered.
So a bulk or trade discount will show as a reduction on the invoice, and the prompt payment
discount will be calculated on the reduced amount.

EXAM TIP!

You are unlikely to be tested on the second option. The AAT will test prompt
payment discounts based on the credit note method. However, you should be
aware that the second method exists.

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