Settlement discount – from a purchaser's perspective under HKAS 2

Settlement discount – from a purchaser’s perspective under HKAS 2

A settlement discount or cash discount is a reduction of the invoice amount offered to the purchasers to encourage them to settle the accounts payable earlier than the normal due date.  Unlike a trade discount, the guidance under HKAS 2 is not very clear for the accounting treatment for the settlement discount from the purchaser’s perspective.  In this article, a hypothetical case is used to illustrate and discuss the possible accounting treatments for the subject issues.   

Pinetree online trading company is a newly established company in Hong Kong selling healthcare products. In a meeting of the accounting department, there was a discussion of the proper accounting treatment of the settlement discount on the purchase of its inventory under the HKFRS. For healthcare product X purchased by Pinetree with the invoice amount of HKD20,000 with a 60-day credit term, a 3% settlement discount is offered by the supplier if the payment is to be settled within 30 days of purchase. Three options were suggested in the meeting as follows:

Option A:

Option B:

Option C:

When deciding which option is the proper accounting treatment under HKFRS, Pinetree would need to refer to HKAS 2 – Inventories. According to this standard, “Trade discounts, rebates and other similar items are deducted in determining the costs of purchase.” However, there is no guidance on the treatment of settlement discount (or cash discount).

Lacking proper guidance under HKAS 2, Pinetree may try to refer to other documents issued by the IFRS Interpretations Committee (IFRIC). Based on the IFRIC agenda decisions in the document - “Inventories - cash discounts IAS (2)” dated August 2002, “ Cash discounts received should be deducted from the cost of the goods purchased.” Furthermore, in a later document - “Discounts and rebates IAS (2)” dated November 2004, “the IFRIC tentatively agreed that settlement discounts should be deducted from the cost of inventories.” As such, option A should not be a proper accounting treatment as the settlement discount is treated as other income instead of a reduction from the cost of inventories.

Although HKAS 2 does not provide clear guidance on the treatment of a settlement discount, it includes a provision for deferred payment terms. According to the standard, “When the arrangement effectively contains a financing element, that element, for example, a difference between the purchase price for normal credit terms and the amount paid, is recognized as interest expense over the period of the financing.” Arguably, the settlement discount and deferred payment term are quite similar in substance, that is to say, there are two prices for a product depending on the time of payments after purchase.

At the end of the meeting, Pinetree concluded that option A should not be adopted as the settlement discount does not reduce the cost of inventories as per the IFRS Interpretations Committee agenda decisions. Pinetree should choose between Option B and Option C. If 60 days is the normal credit term in the industry for product X, Pinetree should adopt Option B. If 60 days is longer than the normal credit term (eg 30 days) so that it contains a financing element, Option C should be adopted. It is also noted that the net effect on the cost of inventories would be the same if the settlement discount is ultimately taken up by Pinetree. There is a difference between Option B and Option C only if the settlement of discount is not taken up by Pinetree. In that case , Pinetree's cost of inventories in Option C would be lower and its gross margin would be higher compared to Option B.

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About the author

Marco Ho, Professor of Practice, School of Accounting and Finance of the Hong Kong Polytechnic University.