“Discount” covers several different things in bookkeeping, and they do not all reach the nominal ledger in the same way. Some never appear at all, some reduce turnover, some reduce costs, and some require a fresh document before the VAT can change. Sorting them out starts with knowing which kind you are dealing with.
| Type | Agreed when | Shown how | Ledger effect |
|---|---|---|---|
| Trade discount | Before the sale | Deducted on the invoice | None: the invoice is posted net |
| Prompt payment discount | On the invoice, conditional on paying early | Offered on the invoice, taken or not | Discount allowed or received, plus a VAT adjustment if taken |
| Volume rebate | After a period of trading | Credit note or rebate statement | Reduces turnover (seller) or cost of sales (buyer) |
| Credit note for returns or errors | After the invoice | Separate credit note | Reverses part or all of the original invoice |
Trade discounts stay off the books
A wholesaler’s list price is £500 and a regular customer gets 15% off. The invoice shows the list price, the discount and a net price of £425 plus VAT. Only £425 is posted to sales and VAT is charged on £425. There is no “trade discounts” account, because the business never earned the £75. Creating one would overstate both turnover and discounts.
Discounts allowed and discounts received
These are the accounts for discounts that are only known after the invoice has been issued, mainly settlement discounts and goodwill reductions.
- Discounts allowed are given to your customers. Under FRS 102, turnover is measured after discounts, so present discounts allowed as a deduction from turnover, not as an overhead. Many older charts put them in expenses; moving them gives a truer gross margin.
- Discounts received come from your suppliers and reduce the cost of what you bought. Post them against cost of sales or the relevant expense heading rather than as other income. Our page on purchases and cost of sales in the chart of accounts covers the buyer’s side in more detail.
Prompt payment discounts and VAT
From 1 April 2015, VAT on a supply with a prompt payment discount is due on the amount the customer actually pays, not on the full price. HMRC sets this out in VAT Notice 700. The supplier has two ways to deal with it:
- issue a credit note for the discount and its VAT when the customer pays early, or
- state the discount terms on the original invoice, including the discounted price, the VAT on it and a note that the customer can only recover the VAT actually paid. No credit note is then needed.
Worked example
A printer invoices £1,000 plus £200 VAT, with 2% off for payment within 10 days. The customer pays £1,176 on day 8.
The original invoice was posted at £1,200 to the customer account. When the payment arrives:
| Account | Debit | Credit |
|---|---|---|
| Bank | £1,176 | |
| Discounts allowed | £20 | |
| VAT control account | £4 | |
| Trade debtors | £1,200 |
Output VAT ends up at £196, which is 20% of the £980 received. The customer posts the mirror image: a £20 credit to discounts received and only £196 of input VAT. If the customer had paid on day 30 at full price, no adjustment would be needed. The early payment discounts account page shows how to track discounts offered but not yet taken.
Credit notes
A credit note is the only correct way to reduce an invoice that has already been issued and recorded. Deleting the invoice or editing its amount after the fact breaks the numbering sequence and the audit trail HMRC expects.
A valid credit note should:
- refer to the original invoice number and date
- show the reduction excluding VAT, the VAT rate and the VAT amount
- explain the reason, such as returned goods, a pricing error or a goodwill gesture
Post it against the same sales account as the original line, or against a returns account if you track returns separately, and reduce output VAT in the VAT period in which the credit note is issued. A credit note received from a supplier reduces your input VAT in the same way.
Common errors
- A credit note without VAT. Reducing the net only leaves output VAT overstated on the return.
- Settlement discounts posted as bank charges because the remittance was short and nobody checked why.
- Volume rebates booked as other income by the buyer, which leaves cost of sales too high and gross margin understated.
- Discounts given by journal directly on the sales account, with no document a customer or HMRC could match.