Settlement under IFRS 15

A settlement discount is where a business offers another business a discount when an invoice is paid early. This is usually a percentage discount if an invoice is paid within a specified number of days, for example, a 5% discount for invoices paid within 15 days.

Settlement discounts can be recorded for both sales and purchase transactions – the discounts that you allow your customers and the discounts that your suppliers give you.

• When prompt payment discounts are offered, it means that the expected consideration is variable (variable consideration) as the amount the entity will receive is dependent upon the customer’s choice as to whether it will take advantage of the discount.

• 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.

IFRS 15 deals with the uncertainty relating to variable consideration by limiting the amount of variable consideration that can be recognized. Specifically, variable consideration is only included in the transaction price if, and to the extent that, probably, its inclusion will not result in a significant revenue reversal in the future when the uncertainty has been subsequently resolved.

When an entity enters into a sale with a customer and a prompt payment discount has been offered, the amount of revenue to be recognized initially will need to be estimated taking into account the probability of the discount being accepted. When the entity expects that the customer will accept the discount, revenue should be recorded net of the discount.

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.

Under IFRS 15 Revenue from Contracts with Customers, there is variability in the transaction price, so, the provisions of IFRS 15 variable considerations are to be applied. 

“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.”

“Variable consideration is only included in the transaction price if, and to the extent that, probably, its inclusion will not result in a significant revenue reversal in the future when the uncertainty has been subsequently resolved.”

 Example 1: The customer will pay promptly

Based on past experiences with a customer, the seller knows for a fact that the customer will pay promptly, then the revenue net of the settlement discount should be recognized at the time of sale.

For example, Adam purchased certain goods for USD 10000 on credit for 30 days.

As a seller, you offered a settlement discount of 3% for payment made within 10 days.

Now, it is known that Adam will pay within as he has always paid promptly.

So, at the time of sale, adjust the transaction price for variability as it is being assumed that the settlement discount will have to be provided.

Journal Entry:

• Debit Receivables: USD 9700 (USD 10000 after 3% discount);
• Credit Sales: USD 9700

Upon receipt of payment:

• Debit Cash: USD 9700; and
• Credit Receivables: USD 9700.

In case, Adam pays after the lapse of 10 days, he will be paying in full i.e., USD 10000:

• Debit Cash: USD 10000,
• Credit Receivables: USD 9700; and
• Credit Sales: USD 300.

Example 2: The customer will not pay promptly

Let’s say, for example, unlike Adam, Smith doesn’t pay promptly. So, in Smith’s case, the revenue is recognized in full and at a later date, if he pays promptly, gets entitled to the discount, the revenue shall be adjusted. 

Journal entry:

• Debit Receivables: USD 10000; and
• Credit Sales: USD 10000

Adjustment, if prompt payment is made:

• Debit Cash: USD 9700;
• Debit Sales: USD 300; and
• Credit Receivables: USD 10000.