3.1 Purchases Invoices, Credit Notes, and Discounts

3.1 Purchases Invoices, Credit Notes, and Discounts

In any business, the purchasing of goods and services on credit is a fundamental activity. To ensure accuracy, completeness, and prevention of fraud or error, a business must implement robust internal controls over its purchasing cycle. This section covers the role of key source documents, the verification processes required to match them, and the calculations for trade and prompt payment discounts under UK VAT regulations.

The Purchasing Cycle and Core Documents

The credit purchasing process is not a single transaction but a series of steps supported by key documents. Bookkeepers must understand the purpose of each document and their sequence:

1. Purchase Requisition: An internal document created by a department requesting the purchase of goods or services. This does not go to the supplier but starts the internal approval process.
2. Purchase Order (PO): Once approved, the purchasing department prepares a formal Purchase Order and sends it to the supplier. The PO is a legally binding offer to buy specific quantities of goods at agreed prices. It includes a unique PO number, description, quantities, agreed unit prices, delivery terms, and delivery address.
3. Goods Received Note (GRN): When the supplier delivers the goods, the buyer's warehouse or receiving staff inspect the delivery. They perform a physical count, verify the condition of the goods, and record the findings on a Goods Received Note. This document lists the items actually received and notes any shortfalls, damage, or rejected items.
4. Supplier Invoice: The supplier sends this billing document to the buyer's finance department. It represents a demand for payment. It must contain the supplier's name, address, VAT registration number, invoice date, unique invoice number, details of goods supplied, net amount, VAT amount, and the total gross amount due.
5. Supplier Credit Note: If goods are returned, or if the supplier overcharges the buyer, the supplier issues a credit note. This document reduces the amount the buyer owes the supplier. It mirrors the invoice but represents a credit to the buyer's account.

The Verification Process: The Three-Way Match

Before recording a supplier invoice in the day books or approving it for payment, the bookkeeping team must verify its accuracy. This is achieved through a control process known as the three-way match, which compares the following:

• The Purchase Order (PO): To verify that the prices and terms billed on the invoice match what was originally authorized and agreed.
• The Goods Received Note (GRN): To verify that the quantities charged on the invoice match the physical quantities actually received.
• The Supplier Invoice: To verify that the arithmetic (unit price × quantity, discounts, VAT, and totals) is correct.

Calculating Discounts Received

In accounting, discounts are incentives that reduce the cost of purchases. Bookkeepers must distinguish between two main types of discounts:

1. Trade (and Bulk) Discounts

Trade discounts are deductions from the supplier's list price. They are given to trade customers or for buying in large volumes.

• Key Rule: Trade discounts are agreed at the time of order and are deducted before the invoice is finalized.
• Accounting Treatment: Trade discounts are never recorded as a separate entry in the accounts. The purchase is simply recorded at the net price (list price minus trade discount).
• VAT Impact: VAT is calculated on the net price after the trade discount has been deducted.

2. Prompt Payment Discounts (PPD)

Prompt Payment Discounts (also called cash discounts) are offered by suppliers to encourage early payment of credit invoices (e.g., "2% discount if paid within 10 days").

• Key Rule: The buyer only receives the discount if they pay within the specified timeframe.
• UK VAT Rules: VAT must be calculated on the actual amount paid. Since the business does not know at the time of invoicing whether the buyer will pay early, the supplier issues the invoice showing the full net and full VAT.
• Adjustment Process: If the buyer pays early and claims the PPD, they pay the discounted gross amount. The supplier must then issue a credit note for the discount amount plus the corresponding VAT to reconcile the difference.

Worked Example: Comprehensive Discount Calculations

A business receives an invoice from a supplier for goods with a list price of £4,000. The supplier offers a 10% trade discount, and a 3% prompt payment discount if paid within 14 days. Standard rate VAT of 20% applies.

Step 1: Calculate Net Price after Trade Discount

• List Price = £4,000.00
• Trade Discount (10%) = £4,000.00 × 0.10 = £400.00
• Net Invoice Amount = £4,000.00 - £400.00 = £3,600.00

Step 2: Calculate VAT and Gross Total on the Invoice

The invoice is issued for the full amount:

• Net Amount = £3,600.00
• VAT (20% of Net) = £3,600.00 × 0.20 = £720.00
• Gross Invoice Total = £3,600.00 + £720.00 = £4,320.00

Step 3: Calculate the Net Payment Due if the PPD is Claimed

If paid within 14 days, the business is entitled to a 3% discount on both the net purchase and the VAT:

• Prompt Payment Discount on Net (3%) = £3,600.00 × 0.03 = £108.00
• Prompt Payment Discount on VAT (3%) = £720.00 × 0.03 = £21.60
• Total PPD (Gross Discount) = £108.00 + £21.60 = £129.60
• Net Payment Due = £4,320.00 - £129.60 = £4,190.40

If the business pays within the 14-day window, it will transfer £4,190.40. The supplier will then issue a credit note for £129.60 (£108.00 Net and £21.60 VAT) to clear the remaining balance in the payables ledger and adjust the VAT control account.