Trade discount and prompt payment discount: the difference

Both discounts are a percentage off a price. They differ in why they are given and in when they are certain.

List price

The full price in the seller's price list.

Trade discount

A percentage taken off the list price. It is given to regular customers and to customers in the same trade. It does not depend on when they pay.

Bulk discount

A percentage taken off for buying a large quantity. On the invoice it works like a trade discount.

Prompt payment discount

A percentage offered to a customer for paying early. It is also called a settlement discount.

The difference is certainty. A trade discount is certain when the invoice is raised, so it is taken off on the invoice.

A prompt payment discount depends on when the customer pays. When the invoice is raised, nobody knows if the customer will pay early. So the invoice shows the full amount, with VAT on the full amount.

VAT is worked out after a trade discount, on the reduced amount.

A prompt payment discount comes off the whole invoice: the net amount and the VAT alike. The credit note for it shows the net discount, the VAT on it and the total.

One invoice can carry both discounts. The seller works through it in this order.

1. Start with the list price: the quantity times the unit price.
2. Take off the trade discount. What is left is the net amount.
3. Work out the VAT on the net amount, and add it. Net plus VAT is the gross total.
4. Record the sale at these figures. Trade receivables is debited with the gross total, Sales is credited with the net amount and VAT is credited. The trade discount is not posted anywhere.
5. State the prompt payment terms on the invoice, and leave the totals as they are.
6. If the customer pays within the time, take the discount off the net amount and off the VAT. The customer pays the gross total less the whole discount.
7. Send a credit note for the discount. Debit Discounts allowed with the net part, debit VAT with the VAT part, and credit Trade receivables with the whole discount.
8. If the customer pays late, the full gross total is due. No discount is recorded.

The credit note puts two things right. The customer's account is cleared, and the seller owes HMRC less VAT.

Whinfell Hardware sells fixings to Beacon Builders, a regular trade customer. The goods have a list price of £1,750.00. Beacon gets a trade discount of 12 per cent.

The trade discount is £210.00, so the net amount is £1,540.00. The invoice shows VAT of £308.00, worked out on the £1,540.00.

Whinfell debits Trade receivables with £1,848.00, credits Sales with £1,540.00 and credits VAT with £308.00. The £210.00 is in no account.

The terms are: 4 per cent discount for payment within 7 days, otherwise pay in 30 days. Beacon pays on day 5, so it takes the discount.

Beacon pays £1,848.00 less £73.92, which is £1,774.08. Whinfell sends a credit note for £73.92.

The receipt is a debit to Bank and a credit to Trade receivables, for £1,774.08. The payment and the credit note together clear the invoice of £1,848.00.

In Beacon's books the credit note is the same entry from the other side. Trade payables is debited with £73.92. Discounts received is credited with £61.60, and VAT is credited with £12.32, because Beacon paid less VAT than the invoice showed.

• Working out VAT on the list price. VAT is worked out after the trade discount, on the net amount.
• Posting a trade discount to Discounts allowed. A trade discount never reaches the ledger. The sale is recorded at the lower amount.
• Taking the prompt payment discount off when the invoice is raised. The invoice shows the full amount, because nobody knows yet when the customer will pay.
• Taking the discount after the time has passed. A late payer owes the full gross total.
• Taking the discount off the net amount only. It comes off the VAT as well.
• Mixing up the two accounts. Discounts allowed is the seller's expense. Discounts received is the buyer's income.

• The net amount on the invoice is the list price less the trade discount.
• The Sales account shows the net amount. No account shows the trade discount.
• On the credit note, the net discount plus the VAT on it equals the whole discount.
• The payment plus the credit note equals the gross total of the invoice, so the customer's account shows nothing owed on it.
• The payment arrived within the time the terms allow.

A rate of VAT is not given here, because rates change. Check GOV.UK for the current rules on VAT and discounts.