Settlement Discount Granted
(Durban, South Africa)
Q: How will the VAT input and output be treated when settlement discount is granted?
A: 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).
Likewise 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.
Because 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...