Financial Accounting · Sales and purchases

Returns, Discounts and Credit Notes in Financial Accounting

Updated 11 October 2026 · Fact-checked

A return is goods sent back, recorded from a credit note. A trade discount is deducted from the list price before any entry is made. A settlement discount is a reduction for early payment, recorded only when it is taken. Returns reverse the original sale or purchase entry.

Understand Returns, Discounts and Credit Notes

Goods are not always kept. A customer may send goods back because they are faulty or wrong. This is a sales return (also called returns inwards) for the seller. For the buyer it is a purchases return (returns outwards). The seller issues a credit note to confirm the reduction in what the customer owes.

A trade discount is a reduction from the list price, often given to regular or bulk buyers. It is agreed before the sale. It is never recorded in the ledgers. You simply record the sale or purchase at the price after the discount.

A settlement discount (also called a cash discount or early payment discount) is offered if the customer pays within a set period. It is a financial matter, separate from the price of the goods. It is a cost to the seller (discount allowed) and a gain to the buyer (discount received).

Under IFRS 15, revenue is measured at the amount the seller expects to receive. In ACCA FA objective tests, though, the standard approach is simple: record the sale at the invoice amount and record the discount when the customer actually pays early and takes it. Read the question wording. If it says the discount has been taken, or that payment was received net of discount, enter it.

In the ledgers, a sales return is a debit to sales returns and a credit to receivables. A purchases return is a debit to payables and a credit to purchases returns. In the financial statements, sales returns are deducted from sales and purchases returns are deducted from purchases. Discount allowed is an expense and discount received is income.

Key formulas to remember

Trade discount: Net price = List price − (List price × trade discount %); No ledger entry for the discount. Record the sale or purchase at the net price.
Settlement discount amount: Discount = Invoice amount outstanding × discount %; Apply it to the amount the customer is paying. Where sales tax is involved, follow the question's instruction on the base.
Sales return entry (seller): Dr Sales returns; Cr Receivables (control account); Posted from the credit note issued. Sales tax, if any, is debited to the sales tax account as well.
Purchases return entry (buyer): Dr Payables (control account); Cr Purchases returns; Posted from the credit note received.
Discount allowed (seller): Dr Cash/bank; Dr Discount allowed; Cr Receivables; Discount allowed is an expense in profit or loss.
Discount received (buyer): Dr Payables; Cr Bank; Cr Discount received; Discount received is income in profit or loss.
Net sales: Net sales = Sales − Sales returns; Net purchases = Purchases − Purchases returns.

How to solve Returns, Discounts and Credit Notes questions

Use this order for any question on returns, discounts or credit notes.

1Decide whose books you are writing: the seller's or the buyer's.
2Identify the item: return, trade discount or settlement discount.
3For a trade discount, reduce the list price first and record only the net amount. Make no separate entry.
4For a return, use the credit note amount. Seller: debit sales returns, credit receivables. Buyer: debit payables, credit purchases returns.
5For a settlement discount, check that it was actually taken. Then calculate it on the amount paid or settled.
6Write the double entry, with debits first, and check that debits equal credits.
7Check where the balances go: returns reduce sales or purchases, and discounts go to profit or loss as expense or income.
8Recompute the receivables or payables balance if the question asks for one.

Quickest way: Credit note and discount shortcut

When to use it: Use this for objective test questions asking which account to debit or credit, or for a quick balance.

Ask: does this reduce a sale or a purchase? If yes, it is a return.
Seller: the customer owes less, so credit receivables. Buyer: the business owes less, so debit payables.
Trade discount: ignore it in the ledgers and use the net price.
Settlement discount: it exists only if payment was made early. The cash received is lower than the balance cleared.
Discount allowed is a debit (expense). Discount received is a credit (income).
Eliminate answer options that put a discount in the sales or purchases account.

Common mistakes in Returns, Discounts and Credit Notes

Recording a trade discount as a separate ledger entry.
Students confuse it with settlement discount because both are called discounts.
Fix: Trade discount is deducted from the price before recording. Only settlement discounts get discount allowed or received entries.
Recording a settlement discount when it was only offered.
The question mentions terms such as 2% for payment within 10 days and students apply them automatically.
Fix: Enter the discount only if the customer paid in time or the question says it was taken.
Debiting receivables for a sales return.
Students remember that receivables are an asset and assume it is always a debit.
Fix: A return reduces what the customer owes, so credit receivables and debit sales returns.
Swapping discount allowed and discount received.
The names look similar and the perspective is easily lost.
Fix: Allowed means you gave it as seller, so it is an expense. Received means you got it as buyer, so it is income.
Putting returns inwards into purchases or returns outwards into sales.
Inwards and outwards describe the direction of goods, which is confusing.
Fix: Returns inwards relate to sales. Returns outwards relate to purchases.
Calculating a settlement discount on the list price rather than the net invoice amount.
Students forget that the trade discount has already reduced the price.
Fix: Apply the trade discount first, then calculate the settlement discount on the resulting invoice amount.

Worked examples

Example 1

Seller A sells goods with a list price of $5,000 to a customer on credit, allowing a 20% trade discount. The customer returns goods with a net value of $400 and then pays the remaining balance within the discount period, taking a 2% settlement discount. Prepare the entries in A's books.

Show the solution

Trade discount: $5,000 × 20% = $1,000. Net invoice = $4,000.
Sale entry: Dr Receivables $4,000; Cr Sales $4,000.
Return: Dr Sales returns $400; Cr Receivables $400. Receivables now $3,600.
Settlement discount: $3,600 × 2% = $72.
Cash received: $3,600 − $72 = $3,528.
Payment entry: Dr Bank $3,528; Dr Discount allowed $72; Cr Receivables $3,600.

Answer: Receivables are cleared to nil. Sales are $4,000, sales returns $400, bank receipt $3,528 and discount allowed $72 (an expense).

Example 2

Buyer B has a payables balance of $8,000 for one supplier. B returns goods worth $1,500 and receives a credit note. B then pays the remaining balance and takes a 3% settlement discount. What is the cash paid and the discount received?

Show the solution

Record the return: Dr Payables $1,500; Cr Purchases returns $1,500.
Balance after return: $8,000 − $1,500 = $6,500.
Discount received: $6,500 × 3% = $195.
Cash paid: $6,500 − $195 = $6,305.
Payment entry: Dr Payables $6,500; Cr Bank $6,305; Cr Discount received $195.

Answer: Cash paid is $6,305 and discount received is $195, which is income.

Exam tips

Read the first line to see whether you are the buyer or the seller. Many wrong answers come from using the wrong side.
In number entry questions, apply the trade discount first, then the return, then the settlement discount, in the order the question gives events.
In multiple response questions, select exactly the number asked. Common pairs are discount allowed as an expense and sales returns as a deduction from sales.
Watch for credit notes in control account questions. They reduce the receivables or payables ledger balance and appear on the credit side of the receivables control account.
Do not spend time on the discount unless the wording confirms it was taken. Look for words such as paid within the discount period.

Practice questions from Sales and purchases

Returns, Discounts and Credit Notes in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Returns, Discounts and Credit Notes: frequently asked questions

What is the difference between a trade discount and a settlement discount?

A trade discount reduces the selling price and is agreed before the sale. It is not recorded in the ledgers. A settlement discount rewards early payment and is recorded as discount allowed or received when taken.

What is the journal entry for a sales return?

The seller debits sales returns and credits receivables, based on the credit note issued. If sales tax was charged, the tax on the returned goods is debited to the sales tax account and receivables are credited with the full amount.

What are returns inwards and returns outwards?

Returns inwards are goods sent back by customers, so they relate to sales. Returns outwards are goods you send back to suppliers, so they relate to purchases.

Is discount allowed an expense or income?

Discount allowed is an expense for the seller and is shown in profit or loss. Discount received is income for the buyer.