What types of discounts can be used, what legal regulations stipulate the issues of discounts and how to correctly account for discounts from the perspective of a provider and recipient of the discount – we will focus on this topic in the following paragraphs of the article. The article discusses purely the accounting perspective in terms of the presentation and valuation of selected types of discounts, it does not address the requirements of tax regulations for documentation and tax treatment of discounts.

Where we can read about discounts in Czech legal regulations

Even though there are so many discounts around us, do not bother trying to find comprehensive and exhaustive legal guidance on accounting for discounts in Czech regulations. Actually, the only regulation which at least mentions discounts is Czech Accounting Standard for Businessmen No. 019 “Expenses and income”. More precisely, this standard offers a very general definition of the discount, in paragraph 4.1.1. as “all items regardless of whether a customer was entitled to the discount in advance, or whether it is an additionally granted discount, for example due to poor quality”. At the same time, it provides a vague guideline on how to connect discounts to a specific accounting transaction: “Discounts and deductions are part of sales for a supplier, however separate sub-ledger accounts may be established for them.” It is possible to say that this definition does not reflect a large range of discounts that are currently available on the market, it is also one-sided – based on the attitude of the supplier, i.e. the one who generates income from performed supplies and then provides a discount from that income.

For this reason, we will have to do with generally applicable accounting principles and experience with their application in practice. We mean primarily the prudence principle, i.e. is the customer actually entitled to receive a discount, or what is the likelihood of meeting the criteria for recognition of turnover bonus, as well as the accruals principle, i.e. recognise discounts in accounts in which the primary transaction was recognised to which the discount relates, and in the period in which the primary discount was made.

Discount, percentage discount, bulk discount or prompt payment discount?

• When we say discount, any price reduction comes in mind which is provided by a supplier to a customer, or a seller to customers.
• Percentage discount is a deduction from the selling price, but unlike a discount, it is usually expressed in percentage terms.
• Bulk discount is perceived as a price reduction for the purchase of a larger than standard quantity in one or several supplies, typically for a certain time period or on a cumulative basis for a historical period.
• Prompt payment discount is a financial benefit based on the condition of early or timely payment.

For all the above terms, there is no clearly defined link of the discount type to the manner of its recognition. Each of the above discussed type of price reduction must be assessed based on specific circumstances when an entitlement for the discount originated. A very important issue in  determining the correct accounting entry is the reason for which the price was reduced, link to the primary transaction from which the price is adjusted, and the period in which the transaction was made.

In general, we can assume that it is appropriate to account for all types of discounts in the same manner as the item, to which the relevant discount relates, was accounted for. If the discount relates to an item that was accounted for through the profit and loss account, in certain expense or income accounts, then it is necessary to account for the discount as a decrease in certain expense or income items. If the discount relates to the acquired asset which has not yet been “used” (usually inventory or assets), it is necessary to recognise the discount as reduction in the value of
a particular asset. Situations may also occur where the discount is not simply included in expenses or income but instead it is for example accrued.

Let us discuss the most frequent types of transactions that generate an entitlement for discount, from the perspective of the provider and the recipient of the discount.

Methods of accounting

The most common method of price reduction is a discount from the originally announced price. For example, a discount from the price stated in a price list of sold material based on an agreement between a supplier and a customer that resulted from poor quality of the supply or late supply.
It is recognised in income of a customer, or in expenses of a supplier, to which it relates and in the period in which the transaction was made.

In the event of a purchase of a larger quantity of material, a bulk discount is provided. The costs of the purchase of material are recognised by the customer, i.e. recipient of the discount to the debit side of account 501 and therefore the provision of the discount decrease these costs to which the discount relates, i.e. the discount is recognised in debit 321/credit 501. If the discount related to items of material in stock, the value of material is directly decreased – debit 321/credit 112. Or there can be a potential concurrence when the discount relates partially to the already used material and partially unused material (in stock) – then it is necessary to divide the discount. The supplier, i.e. the provider of the discount, makes an accounting entry debit 60x / credit 311 due to the provided discount.

The second case may be the provision of a bulk discount for exceeded the purchased quantity for
a certain time period, in practice referred to as turnover bonus. Upon the meeting of defined conditions that are known to the seller and the buyer at the time of the transaction, but the likelihood that they will be met is assessed for a certain time period, the accounting treatment as in the previous case, follows the accounting treatment of the primary transaction.

In practice, there are situations when the turnover bonus can be determined only after the end of the reporting period and according to the fulfilment of the criteria, the bonus is either granted or not. In this case, it is necessary to note the necessity of accounting for estimated payables or reserves pursuant to the likelihood of the discount, upon the meeting of the conditions for such bonuses.

A typical example is a turnover bonus for purchased quantity in a certain time period which exceeds the current reporting period of the company and is consequently assessed only in the following reporting period. In such a situation, if it is likely that the company will meet the condition for being granted the bonus, an accounting estimate is recognised for the anticipated amount of the bonus relating to the current reporting period. For the provider of the discount, it is an outflow of funds, i.e. recognised in debit 60x/credit 389 (or through reserves debit 554/credit 459). For the recipient of the discount, it is an anticipated inflow of funds, i.e. recognised in debit 388/credit 50x (or credit 112). We apply the accrual principle and the prudence principle in order to reflect the impact of the provided bonus in the relevant period, i.e. the current reporting period in which the primary transaction was made to which the bonus relates. If we are unsure about the entitlement for the bonus, we estimate only an adequate part. Or, if we know that we did not meet the limit and we will not be entitled to the bonus, we do not account for an estimated amount. In any event, a company must have its assumption and likelihood of achieving the discount appropriately documented by way of arguments and calculations.

Another case is the price reduction when the payment condition is met, prompt payment discount for a timely payment. If I pay an invoice, as a customer, before the due date, and it is agreed with the supplier, I can reduce the original price by a certain percentage, or an amount known in advance. In this case, we know about the condition for the discount in advance and we use the discount if we meet the conditions for the discount. In practice, these discounts are often accounted for as a financial expense or financial income. An alternative perspective says that prompt payment discounts are neither financial expense nor financial income, they are simply a manner of determining the total amount of supplies on which the buyer agreed with the seller depending on certain contractual conditions determined in a variable manner and then prompt payment discounts are accounted for as other discounts in the operating part of the profit and loss account, as discussed above (or by a decrease in the valuation of fixed assets or inventory). Where is the boundary regarding which procedure should be used? The purchase/selling practice in various industry sectors currently works with discounts in a targeted manner, discounts are reflected in calculations, and systematic interest in discounts is noticeable, rather than an ad-hoc use upon payments. Increased systematic interest evokes work as with other discounts, if it is an ad-hoc use of a prompt payment discount, the presentation of prompt payment discounts in the financial section of the profit and loss account may be appropriate.

Another case when a presentation in the financial section of the profit and loss account is apparently more appropriate may be a situation when a contract between the seller and the buyer sets out a due date which is rather long (e.g. 90 days or more) and concurrently determines the entitlement to the prompt payment discount. In such a case, given the significant length of the time period for which the discount is provided, it is a tool of financial nature and the discount would therefore be a financial expense or income.

In addition to the aforementioned cases of discounts provided, in practice we can come across the provision of discounts such as “every tenth product free”. The customer purchases and recognises ten products at the same reduced cost and the discount is distributed across all the ten pieces received. As for the supplier, the tenth product is issued out of stock at internal expenses just like the preceding nine products and the discount on the provision of the tenth product is reflected in the decreased revenue from the sale, i.e. a lower sales margin.

Not every price reduction can be considered a discount. Another situation concerns the “nomination fee”, which is also sometimes referred to as “pay to play” etc. It consists in the liability of the supplier (usually the producer) to pay a specific amount to its customer for the opportunity to obtain some kind of future order (often not entirely precisely defined), at a specific time, without having already produced let alone supplied anything. For the supplier, the payment represents an additional expense reported in the current period or accrued over the duration of the project or the contract term. The accounting professional has to consider, among other things, whether the “nomination fee” can be considered a “marketing” expense with the objective of maintaining the position on the market or increasing turnover, and assess whether it is possible to identify the benefit provided in relation to individual deliveries, especially if such a direct connection is not defined by the supplier. Then the payment received from the supplier is recognised in other operating income.

In any case, we recommend including the selected method of recognising and reporting the individual discounts in an internal policy or directive to ensure a consistent approach in similar cases in the future. The notes to the financial statements should describe the methodology for the users.

Conclusion

We acknowledge that the current system of using discounts has become part of our lives and it is a very effective tool used to influence customer consumer behaviour. It is necessary to keep correct accounting records of discounts. Understanding the reasons for price reduction in relation to the primary transaction to which the discount relates is helpful in presenting true and fair accounting records. The notes should also describe types of discounts and their accounting treatment for users of the financial statements.

Let us add that other interesting marketing tools containing elements of discount that are widely used and have very specific features include various forms of loyalty programmes. These should always be addressed on an individual basis, which places considerable demands on accounting professionals, not to mention the potential increased variability caused by reporting under IFRS (especially with respect to IFRS 15 Revenue from Contracts with Customers).

The article is part of dReport – October 2019, Accounting news.