Settlement Discount Granted

by Yoli
(Durban, South Africa)

VATQ: How will the VAT input and output be treated when settlement discount is granted?

For those who aren't familiar with this term, VAT is short for Value-Added Tax. This is a tax on the "value" a business "adds," which is usually the same as the profit you make. It is basically a sales tax and is added to the price that you're selling an item at.

VAT is a tax that is charged in many countries around the world and at differing rates in each country. Some countries do not charge VAT but rather have a General Sales Tax (GST).

Now recording VAT is not so straightforward - you have 2 accounts when you're recording VAT,
VAT Input and VAT Output .

VAT input is recorded whenever there is an expense or asset purchased. VAT input means you're claiming money from the tax authorities (you're recording a debtor/receivable).

VAT output is recorded when you make income. VAT output means you owe more money to the tax authorities (you're recording a creditor/payable). Usually the VAT Output is much greater than the VAT Input, which means the business has a tax liability and owes VAT overall.

Settlement discount is the same as a cash discount and is a discount granted for paying off a debt early.

Settlement discount granted is an expense. The opposite of this is settlement discount received , which is an income for your business.

settlement discount granted is an expense, we record VAT input .

Here's an example to show what happens when we have a settlement discount.

Let's say VAT is 10% and we sell an item usually worth $100 ($110 with VAT included) for only $88.

The entries would be:

Dr Bank $88
Dr Discount granted $20
Dr VAT input $2
Cr Sale $100
Cr VAT output $10

VAT output is recorded because of the income, the sale. VAT input is also recorded because of the expense, the discount granted.

The discount of $22 ($110 - $88) is divided 100:10 into 100% expense (discount) of $20 and 10% VAT input ($2). The $22 is essentially 110% (100% + 10%).

Hope that makes sense...

Michael Celender

Comments for Settlement Discount Granted

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by: Kwazi

Thank you so much Michael, this is really helpful.

You're welcome.

- Michael
Founder of Accounting Basics for Students

VAT for cash discount
by: Nadeem

As per my knowledge, VAT is charged on net of discount amount. That should be 88*10%= 8.8

Allowance for settlement discount granted
by: Anonymous

If I am asked to calculate net turnover do I also add allowance for settlement discount granted?

Settlement Discount Received & Vat Output
by: Michael

Yes, because settlement discount received is an income we then record VAT output (a liability account - meaning we owe VAT).

settlement discount vat input/output
by: Anonymous

So when receiving a settlement discount is it VAT output then?

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