How to account for settlement discounts under IFRS 15?
Today’s question is not so much a question, but a nice discussion I had with Mr. David Kolitz, an academic from the University of Exeter in the UK and author of financial accounting textbooks.
However, I do believe that this little discussion can be beneficial for practitioners and accountants, too, because it is so frequent.
So, David asked me about my opinion about accounting for settlement discounts.
Let’s say that an entity that sells goods on credit for 100 and offers 10% settlement discount if the customer pays within 10 days. Otherwise, the full amount is to be paid after 30 days.
How should we account for it?
Should we initially record the revenue net of discount and if the client pays later, then adjust the revenue for the discount?
Or, should we record the deferred interest income at the time of sale amounting to the amount of discount?
What is a settlement discount?
To make it absolutely clear for everyone:
Settlement discount is a discount for prompt payment of invoice by the customer.
Let’s say you sell something for 1 000 on 30-day credit and you offer 3% off if a customer pays within 10 days. Those 3% – or 30 in this case – is a settlement discount.
Settlement discounts: IAS 18 vs. IFRS 15
In my opinion – under older IAS 18 Revenue, income from the sale on credit was recognized in full and the discount (if a customer paid promptly) was recognized as expenses at the time of payment.
However, under IFRS 15 Revenue from Contracts with Customers, it is clear that there is a variability in the transaction price and thus we must apply the provisions of IFRS 15 about variable consideration.
IFRS 15 says that “Where a contract contains elements of variable consideration, the entity should estimate the amount of variable consideration to which it will be entitled under the contract. ” (par. 50)
Also, par. 56 states that “variable consideration is only included in the transaction price if, and to the extent that, it is highly probable that its inclusion will not result in a significant revenue reversal in the future when the uncertainty has been subsequently resolved. ”
Therefore in my opinion, the seller must first assess the probability of customer paying promptly.
Let me illustrate what happens under different scenarios.
Seller assumes that customer WILL pay promptly
If past evidence or other information indicate that yes, a customer will pay promptly, then the seller should recognize the revenue net of settlement discount at the time of sale.
As an example, let’s say you make a sale of 1 000 to customer John on credit for 30 days.
You offer settlement discount of 3% if John pays within 10 days.
From the past experience with John you expect him to pay within a week because John has always paid you within a week.
Therefore, at the time of sale, you adjust the transaction price for variability because you assume that you will have to provide settlement discount.
Your journal entry is therefore:
- Debit Receivables: CU 970 (CU 1 000 after 3% discount);
- Credit Sales: CU 970
You should not recognize any deferred interest income, because we are not talking about the significant financing component here.
When John pays you within 10 days, you simply:
- Debit Cash: CU 970; and
- Credit Receivables: CU 970.
However, if John pays you after 10 days, then he needs to pay the full 1 000 and in this case, you will simply adjust the revenue as:
- Debit Cash: CU 1 000,
- Credit Receivables:CU 970; and
- Credit Sales: CU 30.
Seller assumes that customer WILL NOT pay promptly
In this case, the revenue is recognized in full and if a customer later pays promptly and is entitled to a discount, then the revenue is adjusted.
Let’s say you make the same sale to different customer, George, but George really likes to take him time and pay after 30 days.
You do not expect he would be entitled to a settlement discount, so you book:
- Debit Receivables: CU 1 000; and
- Credit Sales: CU 1 000
And when George makes a payment within 10 days against your expectations, then you simply adjust the revenue.
- Debit Cash: CU 970;
- Debit Sales: CU 30; and
- Credit Receivables: CU 1 000.
Settlement discounts: Practical point
Companies often assess the clients individually as each client can have slightly different habits of making payments, so it’s not unusual to record sales both ways at the same company for different customers.
However – good documentation is necessary here.
Any comments or questions?
Please let me know below – thank you!
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Thanks for your web page and job. Under IAS 18 or Section 23 of IFRS EPYM, how would you recognize the revenue from a sales when the entity state a volumen discount (retrospective, i.e, it applies to all purchases)?
why refund liability and A/c Receivable will not be booked by $30 (3% discount of Transaction Price). I am partially agree with the treatment that revenue should be booked net of discount but A/c Receivable should always be booked at gross amount and the remaining difference will be Refund Liability. Please maam correct me, why Refund liability is not booked here. I am confused!!!
What if its the first time that the company offers credit sales in total? how do you do the assessment since we don’t have any past credit records?
Industry benchmarks always work. If not – then you need to come up with some solution available in your country and business. IFRS won’t tell you.
Firstly, does soccer club membership fees fall under IFRS15? It is a new club (1 March 2020) and discounts are granted for members who pay their full membership fee before the season starts. However, if it does fall under IFRS15 then I assume you have to account for the gross fees?
Hi Marco, yes, apply IFRS 15. The discounts are a part of a variable consideration and the transaction price takes it into account (so does the revenue).
Good day Silvia, We appreciate you for the wealth of knowledge.
How should discount offered to students in an educational institution be treated in line with IFRS 15. Such discounts include; pay 75% of the school fee when your younger sibling gains admission to the school, pay 50% school fee for your relatives or immediate family members when you are a member of staff of the university
this is the first time we are offering early setllement discount to a customer (who is a new customer, btw).
this means we are not able at this point in time to assess how prompt the payment will be.
would you recognize the full amount?
Well, try to assess based on other similar customers and the past experience with them.
What happened if after recognising revenue net discount at the time of sale, but after 30 days customer goes against your assumption by not paying promptly. Do we adjust revenue back to full amount.
Right now, for my company, we not only offer a certain % discount if customers pay within a certain time, some customers also charge us certain % amount based on gross sales(they call that product damage fee and marketing support fee, non-refundable), we deduct those amounts directly from the invoice(the agreement says those fees will be deducted from the payment to us), I wonder whether we are doing correctly ,should they be treated as a reduction of revenue at the time of invoicing, or as a reduction of revenue when we actually receive payment, or those fees should be treated as a cost? can you please explain where I can find the related IFRS regulations on this?
Hi Maggie, not many details, but in general, the discounts depending on the gross sales are taken into account right when assessing the transaction price (i.e. at the time of sale). S.
Thanks for the quick response, you are the best!
Just have a follow up question, the damage fee and marketing support fee is just a simple statement in the contract, it didn’t say what exactly they are, since the customer will deduct the fee on the payment to us no matter what, they don’t look like variable considerations to me, they are more like a fixed fee, under IFRS 15, what should they belong to?
How will the same situation be handled from a buyer’s perspective?
Hi Hossam, as the buyer, you should treat settlement discount as any other discount – i.e. deduct it from the cost of what you are buying (inventories, or property, plant and equipment…). It is NOT treated as financial income. S.
I still have issues with this part of IFRS 15 because settlement discount does not play any decisive role in the customer buying my product or not. I believe in treatment of IAS 18 than the new treatment of IFRS 15. In my own opinion it is only trade discount that should bring down my revenue and not settlement discount.
IFRS 15 does not distinguish between “trade discount” or “settlement discount”. Also, it does not speak about decisive factors or not. As I explained – under IFRS 15, settlement discount is a variable consideration and you must make the most probable estimate of it.
I agree with Sylvia. Under IFRS 15, the income needs to be reported net of the discount.
why refund liability and A/c Receivable will not be booked by $30 (3% discount of Transaction Price). I am partially agree with the treatment that revenue should be booked net of discount but A/c Receivable should always be booked at gross amount and the remaining difference will be Refund Liability. Please sir correct me, why Refund liability is not booked here. I am confused!!!