Learning objectives
By the end of this chapter you will be able to:
- Explain the purchasing cycle for credit purchases, including trade discounts and how they affect the invoice amount recorded.
- Interpret settlement discount terms and calculate the cash payable when payment is made within the discount period.
- Adjust amounts payable for returns, allowances, and credit notes to determine the net balance due.
- Calculate cash outflows for partial settlements, including the correct treatment of non-discountable charges.
- Record journal entries for purchases and related supplier transactions using correct double-entry logic.
- Identify common errors in recording purchases and trade payables and explain how they affect the financial statements.
Overview & key concepts
Businesses often buy goods and services on credit. When a supplier allows time to pay, the buyer records:
- an expense (for services or overheads), or an asset (inventory) for goods bought for resale or production; and
- a liability called trade payables (amounts owed to suppliers).
This chapter focuses on the mechanics of:
- trade discounts (reduce the invoice price recorded),
- settlement discounts (reduce the cash paid if payment is made early),
- credit notes (reduce what is owed), and
- partial payments and charges excluded from discount terms (which can change the discount calculation).
Accurate recording protects profit measurement, supplier balances, and cash flow reporting.
The purchasing cycle on credit
A typical credit purchase follows this flow:
- Order and delivery of goods/services.
- Invoice received from the supplier.
- Adjustments agreed (returns, allowances, pricing corrections), often documented by a credit note.
- Payment (possibly early to obtain a settlement discount, or later at full amount due).
Trade discounts
A trade discount is a reduction from a supplier’s list price, usually linked to volume, customer status, or negotiated terms.
- The accounting record is made at the net amount shown on the invoice (after trade discount).
- Trade discounts are not recorded as a separate “discount” entry, because the invoice itself is already at the reduced price.
Illustration List price USD 1,000 less 10% trade discount = invoice price USD 900. Record USD 900 as the cost (expense or inventory) and USD 900 as the trade payable.
Settlement discounts (early payment incentives)
Suppliers sometimes reward fast payment. The invoice remains payable in full, but if the buyer pays quickly, the supplier accepts a lower cash amount.
Discount terms are commonly shown in a compact format such as 2/10, net 30, which indicates:
- pay within 10 days and you may reduce the amount you pay by 2% (on the portion the supplier says qualifies); otherwise
- the balance must be settled in full within 30 days.
In most questions, treat the settlement discount as recognised only when it is earned (i.e., when payment is actually made within the time limit), unless the requirement instructs an alternative approach.
Order of operations
When calculating the final amount payable and the cash paid, use a consistent sequence.
- Start with list price (if provided).
- Apply trade discount → this gives the invoice price to record.
- Separate any amounts excluded from discount terms (if stated), such as specific delivery/handling charges.
- Apply credit notes/returns/allowances to the relevant balances.
- Identify what is paid within the discount window (full, partial, or none).
- Calculate settlement discount on the qualifying portion settled within the time limit.
- Compute cash paid and clear the payable(s) using correct double entry.
- Record bank fees separately (they affect cash and expenses, not the supplier balance).
Quick comparison: trade discount vs settlement discount vs credit note
- Trade discount
- Settlement discount
- Credit note
Adjustments before payment
Suppliers may issue credit notes for:
- goods returned,
- allowances granted (e.g., damaged goods retained at a reduced price), or
- pricing corrections.
A credit note reduces the supplier balance and reduces the related cost recorded.
- If the original purchase was recorded as inventory, the credit note normally reduces inventory cost.
- If the original purchase was recorded as an expense, the credit note reduces that expense.
Where settlement discount terms apply, the discount is usually calculated on the net qualifying balance after credit notes.
Partial settlement
If only part of an invoice is settled within the discount period:
- apply the settlement discount only to the qualifying portion paid within the time limit.
Common twist: when cash paid is given
Sometimes the cash amount paid is provided, and you must work backwards to find the gross amount of qualifying balance settled.
If the settlement discount rate is d%, then:
- Qualifying amount settled (gross) = Cash paid ÷ (1 − d)
- Example: cash paid USD 4,410 with a 2% discount
- Qualifying amount settled = 4,410 ÷ 0.98 = 4,500
Charges excluded from discount terms and bank fees
Charges excluded from discount terms
A charge described as “non-discountable” is a commercial term (it affects how the settlement discount is calculated). It is not an accounting label.
- A delivery charge may or may not qualify for settlement discount depending on the supplier’s terms.
- Regardless of whether it qualifies for settlement discount, delivery can still be part of inventory cost if it is directly linked to getting the goods ready for sale or use (for example, transport to your premises or warehouse).
Bank fees
Bank charges:
- increase total cash outflow,
- are recorded as a separate expense, and
- do not change the supplier’s invoice balance or the settlement discount calculation.
Core theory and frameworks
Double-entry logic
Goods bought on credit (for resale/production):
- Dr Inventory
- Cr Trade payables
Services/overheads bought on credit:
- Dr Expense
- Cr Trade payables
Credit note received (return/allowance/pricing correction):
- Dr Trade payables
- Cr Inventory (or Expense, depending on what was originally debited)
Payment to supplier:
- Dr Trade payables
- Cr Cash/Bank
Settlement discount earned (common recording):
- Dr Trade payables (for the portion being cleared)
- Cr Cash/Bank (cash actually paid)
- Cr Discount received (benefit from early payment)
Practice point for inventory purchases: For inventory, the settlement discount is commonly treated as reducing the purchase cost (reducing inventory if still held, or reducing cost of sales if the related inventory has already been sold), unless the question specifies a separate “discount received” presentation.
Impact on financial statements
- Credit purchases increase trade payables and increase inventory (or expenses).
- Credit notes reduce trade payables and reduce the original cost recorded.
- Payments reduce cash and reduce trade payables.
- Settlement discounts and bank fees affect profit and therefore retained earnings.
Worked example
Narrative scenario
ABC Ltd buys goods on credit from Supplier X under the following terms:
- List price of goods: USD 10,000
- Trade discount: 10%
- Settlement discount terms: 2/10, net 30
- Delivery charge: USD 200 (excluded from settlement discount terms)
- Credit note for pricing error: USD 500
During the month, ABC Ltd:
- Purchases goods (list price USD 10,000) on credit.
- Receives the trade discount (10%) on the invoice.
- Receives a credit note for USD 500 due to a pricing error.
- Pays USD 4,500 of the goods balance within the discount period.
- Pays the remaining supplier balance after the discount period.
- Incurs a bank fee of USD 50 on the later payment.
Required
- Calculate the net payable amount after trade discount and the credit note.
- Determine the cash outflow for the partial settlement within the discount period.
- Record the journal entries for each transaction.
- Explain the impact on the financial statements.
Solution
1) Net payable after trade discount and credit note
Goods element (qualifying for settlement discount):
- List price: USD 10,000
- Less trade discount (10%): (USD 1,000)
- Invoice price (goods): USD 9,000
- Less credit note (pricing error): (USD 500)
- Net goods payable: USD 8,500
Delivery charge (excluded from settlement discount terms):
- Delivery charge: USD 200
Total trade payable before any payment:
- Net goods payable: USD 8,500
- Plus delivery charge: USD 200
- Total trade payable: USD 8,700
2) Cash outflow for the partial settlement within the discount period
ABC Ltd pays USD 4,500 of the goods balance within the discount period.
- Settlement discount = 2% × USD 4,500 = USD 90
- Cash paid to supplier for that settlement = USD 4,500 − USD 90 = USD 4,410
Cash outflow for the early partial settlement: USD 4,410
3) Journal entries
(Goods are purchased for resale, so inventory is used.) (If the goods and delivery charge appear on the same supplier invoice, the entries in (a) and (b) can be combined.)
(a) Record the goods invoice (after trade discount)
- Dr Inventory........................................ USD 9,000
- Cr Trade payables................................... USD 9,000
(b) Record the delivery charge
- Dr Inventory........................................ USD 200
- Cr Trade payables................................... USD 200
(c) Record the credit note (pricing correction)
- Dr Trade payables................................... USD 500
- Cr Inventory........................................ USD 500
After (a)–(c), the trade payable balance is: USD 9,000 + 200 − 500 = USD 8,700
(d) Partial settlement within discount period (goods element)
- Dr Trade payables................................... USD 4,500
- Cr Cash/Bank........................................ USD 4,410
- Cr Discount received................................ USD 90
Alternative presentation for inventory purchases (if required): credit Inventory (if the inventory is still on hand) or credit Cost of sales (if already sold) instead of using a separate “discount received” line.
Trade payables remaining after (d): USD 8,700 − 4,500 = USD 4,200
(e) Pay the remaining balance after the discount period
Remaining balance: goods USD 4,000 + delivery USD 200 = USD 4,200)
- Dr Trade payables................................... USD 4,200
- Cr Cash/Bank........................................ USD 4,200
(f) Record the bank fee on the later payment
- Dr Bank fees expense................................ USD 50
- Cr Cash/Bank........................................ USD 50
After (e), the supplier balance is cleared to nil.
4) Impact on financial statements
Statement of financial position
- Inventory increases by USD 8,700 overall (USD 9,000 + 200 − 500).
- Trade payables increase to USD 8,700 then reduce to nil after payments.
- Cash/Bank decreases by USD 8,660 in total (USD 4,410 + 4,200 + 50).
Profit or loss
- Settlement discount benefit: USD 90 (presented either as “discount received” or as a reduction of inventory/cost of sales depending on presentation and timing).
- Bank fee expense: USD 50.
Net profit impact from these items: + USD 40.
Interpretation of the results
ABC Ltd’s supplier balance totalled USD 8,700, including delivery that did not qualify for settlement discount under the stated terms. By paying USD 4,500 of the goods balance within the discount period, ABC Ltd reduced cash paid for that portion by USD 90. The bank fee increased cash outflow but did not affect the supplier balance or the discount calculation. The entries ensure that inventory cost, supplier balances, and cash movements reconcile clearly.
Common pitfalls and misunderstandings
- Recording purchases at list price: record the invoice net of trade discount.
- Recording trade discount separately: trade discount is reflected in the invoice price, not posted to a separate account.
- Applying settlement discount to the wrong base: apply it only to the qualifying amount settled within the time limit (and after relevant credit notes).
- Mixing up “excluded from settlement discount terms” with “expense”: a charge can be excluded from discount terms and still be part of inventory cost if directly attributable.
- Ignoring credit notes before discount calculations: credit notes reduce the payable and often reduce the cost recorded.
- Incorrect partial settlement handling: the discount applies only to the portion settled early; the remainder is paid at full amount.
- Not grossing up when cash paid is given: qualifying settled = cash ÷ (1 − discount%).
- Netting bank fees into the supplier account: bank fees are separate expenses, not part of trade payables.
Summary and further reading
Credit purchases create trade payables and either inventory (for goods) or expenses (for services/overheads). Trade discounts reduce the amount recorded from the outset. Credit notes reduce both the supplier balance and the original cost recorded. Settlement discounts reduce cash paid only when earned and are commonly treated as reducing inventory cost (or cost of sales if the related inventory has been sold), unless a separate “discount received” presentation is specified. Charges excluded from settlement discount terms affect the discount calculation but do not determine whether a cost is capitalised or expensed. Bank fees are recorded separately and increase cash outflow without affecting the supplier balance.
FAQ
What is the difference between a trade discount and a settlement discount? A trade discount reduces the list price to the invoice amount recorded. A settlement discount reduces the cash paid if the buyer pays within a specified time window.
How should a credit note be recorded? A credit note reduces trade payables and reduces the original cost recorded (inventory for goods; an expense for services/overheads).
Does “non-discountable delivery” mean delivery is always an expense? No. “Non-discountable” refers to discount terms (how settlement discount is calculated). Delivery can still be added to inventory cost if it is directly linked to getting the goods ready for sale or use.
How do you deal with partial payments under settlement discount terms? Apply the discount only to the qualifying portion paid within the discount period. If the cash paid is given, gross up to the qualifying amount settled using cash ÷ (1 − discount%).
Do bank fees affect the supplier balance or discount calculation? No. Bank fees are recorded separately as an expense and do not alter trade payables or settlement discount calculations.
Glossary
Trade payables (accounts payable) Amounts owed to suppliers for goods or services purchased on credit.
Trade discount A reduction from a supplier’s list price used to arrive at the invoice amount. It is reflected in the invoice price and is not recorded as a separate discount entry.
Settlement discount (cash discount) A reduction in the cash amount payable if the buyer pays within an agreed early payment period.
Credit note A supplier document that reduces the amount payable, commonly issued for returns, allowances, or pricing corrections.
Charges excluded from settlement discount terms Amounts that must be paid in full and are excluded from settlement discount calculations under the supplier’s payment terms (for example, certain delivery charges).
Partial settlement Payment of only part of an outstanding supplier balance, requiring careful discount calculation if early payment terms apply.
Invoice price The amount charged after trade discounts, recorded as the cost and the payable.