4.3 Allocating Receipts, Payments, and PPD

Allocating Receipts, Payments, and PPD

In credit transactions, recording a payment or receipt in the cash book is only the first step. To maintain accurate financial records, these cash movements must be systematically matched and applied to the corresponding invoices and credit notes in the accounting system. This process is known as allocation.

Allocating Receipts and Payments

When a customer pays an outstanding invoice, or when the business pays a supplier, the transaction is recorded in the main cash book. However, this does not automatically show which specific purchases or sales have been settled.

• Customer Allocation (Sales Ledger): When a bank receipt is entered (Debit Bank, Credit Trade Receivables Control Account), the bookkeeper must allocate the receipt against the specific sales invoices within the customer's account in the Sales Ledger. This updates the customer’s outstanding balance.
• Supplier Allocation (Purchase Ledger): When a payment is made (Credit Bank, Debit Trade Payables Control Account), the payment must be allocated against the corresponding supplier invoices in the Purchase Ledger to show that the liability has been settled.

Proper allocation is essential for:

• Aged Receivables and Payables Reports: Ensuring the business knows exactly which invoices are overdue and require chasing, and which suppliers are due for payment.
• Discrepancy Identification: Highlighting errors, underpayments, or overpayments quickly.

Handling Ledger Adjustments

When cash received or paid does not exactly match the outstanding invoice balance, ledger adjustments are required:

• Underpayments: If a customer underpays (e.g., paying £290 instead of £300 due to a disagreement over delivery costs), the invoice remains partially unpaid. The remaining £10 stays as a debit balance on their account.
• Overpayments: If a customer accidentally overpays, their account in the Sales Ledger will show a credit balance. The bookkeeper can either refund the overpayment (Debit Customer Account / TRCA, Credit Bank) or carry the credit balance forward to offset a future invoice.
• Supplier Refunds: If a supplier refunds the business for returned goods or an overpayment, it is recorded in the cash book (Debit Bank) and credited to the supplier's account in the Purchase Ledger (and TPCA in the General Ledger).

---

Prompt Payment Discounts (PPD)

A Prompt Payment Discount (PPD)—also known as a cash discount—is an offer by a supplier of a percentage reduction in the invoice price if the customer pays within a specified short timeframe (e.g., "2% discount if paid within 10 days").

UK VAT Rules and AAT Level 2 Treatment

In the UK, VAT must be accounted for on the actual amount paid by the customer. However, when the initial invoice is raised, the supplier does not know whether the customer will pay early and take the discount.

Under AAT Level 2 bookkeeping rules, the accounting procedure follows these distinct stages:

1. Raise the Invoice for the Full Amount: The invoice is recorded at the maximum gross price (full sales price plus 20% VAT on the full net price).
2. Record the Payment Net of Discount: If the customer pays early, they deduct the discount and pay the reduced amount. The receipt is recorded in the cash book for the exact amount received.
3. Adjust using a Credit Note: Because the customer paid less, their account in the Sales Ledger will show a remaining outstanding balance (the value of the discount plus the VAT on that discount). To clear this balance and adjust the records, the supplier must issue a credit note for the discount.

This credit note serves two purposes: it reduces the sales revenue (or records a discount allowed expense) and reduces the output VAT liability in the VAT Control Account.

---

Worked Example: Customer PPD Adjustment

Scenario:

• A company sells goods to customer Y. Bandy on credit.
• Invoice details: Net £2,000, VAT (20%) £400, Gross £2,400.
• PPD terms: 3% discount if paid within 7 days.
• Y. Bandy pays within 5 days and takes the discount.

Step 1: Record the Initial Invoice

The invoice is recorded in the Sales Day Book and posted to the general ledger:

• Debit Trade Receivables Control Account / Y. Bandy Account: £2,400 (Gross)
• Credit Sales Account: £2,000 (Net)
• Credit VAT Control Account: £400 (VAT)

Step 2: Record the Payment Received

The customer calculates their payment:

• Gross Discount: $£2,400 \times 3% = £72.00$
• Net Payment Due: $£2,400 - £72.00 = £2,328.00$ The cash book records the receipt of £2,328:
• Debit Bank: £2,328
• Credit Trade Receivables Control Account / Y. Bandy Account: £2,328 At this stage, Y. Bandy’s ledger account shows a remaining debit balance of £72.00.

Step 3: Issue the Credit Note for the Discount

To clear the account, the company calculates the net and VAT components of the £72 discount:

• Net Discount Allowed: $£2,000 \times 3% = £60.00$
• VAT Adjustment: $£400 \times 3% = £12.00$ (or $£72.00 \times 1/6 = £12.00$)
• Gross Credit Note Value: £72.00 The credit note is recorded:
• Debit Sales (or Discounts Allowed) Account: £60.00
• Debit VAT Control Account: £12.00
• Credit Trade Receivables Control Account / Y. Bandy Account: £72.00 This credit note entry reduces the output VAT liability (as the company collected less VAT than originally invoiced) and reduces the sales revenue, while completely clearing the customer's ledger account.

---

Supplier PPD (Discounts Received)

The same logic applies when the business takes a prompt payment discount from a supplier.

1. Record Invoice: The supplier invoice is entered at full value: Debit Purchases (Net), Debit VAT Control Account (VAT), Credit Trade Payables Control Account (Gross).
2. Make Payment: The business pays the net-of-discount amount: Credit Bank, Debit Trade Payables Control Account.
3. Record Supplier Credit Note: The supplier issues a credit note to adjust the discount. The business records it:
   • Debit Trade Payables Control Account: (Gross discount)
   • Credit Purchases (or Discounts Received) Account: (Net discount)
   • Credit VAT Control Account: (VAT on discount) This adjusts the purchase costs downward and reduces the input VAT that can be claimed from HMRC.

---

Trade Discount vs. Prompt Payment Discount (PPD)

It is crucial for exam candidates to distinguish between Trade Discounts and Prompt Payment Discounts:

• Trade Discount: Offered to customers for buying in bulk or being in the same trade. It is deducted before the invoice is created. Therefore, the sales invoice is written for the already-reduced price, and VAT is calculated on this net-of-trade-discount figure. No credit note is needed.
• Prompt Payment Discount: Offered to encourage early payment. It is a contingent discount that may or may not be taken. The invoice is raised for the full gross amount. If the discount is taken, the transaction is adjusted later via a credit note.