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Settlement Discounts on Credit Notes

How to Calculate Settlement Discounts on Credit Notes

Do You Have to Calculate Settlement Discounts on Credit Notes?

Following on from our BLOG on ‘How to Calculate Settlement Discounts’, someone sent us this interesting question:

A settlement discount of 2.5% was offered to a client if payment was made within 15 days.

Net Total Invoice = £100
VAT = £19.50
Gross = £119.50

Some goods amounting to Net of £25, relating to this invoice were returned, so a credit was issued. Will the VAT of the credit note will be calculated as £4.87 – hence taking into consideration the settlement discount or not?

If settlement discount is also considered on the credit note, what will the payment amount to if both invoice and credit note are settled within the 15 days?

“Will the VAT of the credit note will be calculated as £4.87 – hence taking into consideration the settlement discount or not?”

Question 1 Answer (Settlement Discounts on Credit Notes):

YES, the settlement discount given on the invoice should be taken into account when preparing the Credit Note. If you don’t do this, you could end up paying the customer more than they paid you! The settlement discount calculation is therefore spot on, in that the VAT on the Credit Note will be £4.87. Here’s a breakdown of the calculations:

Credit Note:

Net total: £25.00

VAT: £4.87

Gross: £29.87

Workings:

£25.00 x 2.5% = £0.63 (£0.625 rounded up)

£25.00 minus £0.63 = £24.37

£24.37 x 20% = £4.87

£25.00 + £4.87 = £29.87

Question 2 Answer (Total Amount Payable After Discounts):

“What will be the total amount payable by the customer if both the invoice and Credit Note are settled within the 15 days?”

Invoice:

The gross amount (total amount payable) shown on the invoice is £119.50. As the customer settled the invoice within 15 days, they can deduct the 2.5% discount. To calculate what this is, take the Net amount figure and multiply it by 2.5% i.e.

£100 x 2.5% = £2.50.

The amount the customer will actually pay on this invoice is therefore:

£119.50 minus £2.50 = £117.00

Credit Note:

We then have to apply the same principle with the Credit Note.

We know that the settlement discount on the Credit Note is £0.63, so we simply deduct this from the Credit Note total i.e.

£29.87 minus £0.63 = £29.24

So, £29.24 is the amount that will be refunded to the customer.

Total amount payable by the customer:

The total amount payable by the customer is therefore the invoice total (discounted total) discount minus the credit note (discounted total) i.e.

£117.00 minus £29.24 = £87.76

I hope that makes sense, but if anyone has any further queries, do let us know!

 

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