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Following is the Question No 41 from Kaplan’s Exam kit(Feb 2014-Aug 2015)
Erin is Registered for sales tax. During May, she sells goods with tax exclusive price of $600 to Kyle on credit. As Kyle is buying a large quantity of goods, Erin reduces the price by 5%. She also offers a discount of another 3% if Kyle pays within 10 days. Kyle does not pay within the 10 days.
If sales tax is charged at 17.5%, what amount should Erin charge on this transaction?
A. $96.76 B. $101.85 C. $99.75 D. $105.00
For me answer for this question will be:
600 X 0.95 X 0.175 = 99.75 (i.e option C)
(after only deducting trade discount)However, Answer on the exam kit is:
600 X 0.95 X 0.97 X 0.175 = 96.76 >> Option A.And it further explains:
Sales tax is always charged on the selling price net of:
– actual trade (bulk buy) discounts given
– settlement (prompt payment) discounts, regardless of whether they are taken.Henceforth, my question is, is this answer and explanation really correct?
Yes – the answer really is correct 🙂
The tax is calculated after subtracting all discounts (both trade and settlement) whether or not they actually end up taking the settlement discount.
However, although we used to have that in our Course Notes, I do not really think it can be asked in the exam (which is why I removed it) because it is testing specific tax rules. Specific rules like this are only examinable in Paper F6 (the tax exam).
Interesting… and I am glad I asked this question here. Because, according to my college lecturer, (btw, I study full time in Sri Lanka), that answer is wrong and he claims to have inquired with an examiner from ACCA.
Nonetheless, could I go and further ask you how will the double entry be? (though not in this syllabus, I am curious to know)
Will it be like:
Kyle – Dr $ 649.66
Sales – Cr $ 552.90
Sales tax – Cr $ 96.76…… ??What about the settlement discount that was allowed for? How can settlement discount be allowed for at the time of raising invoice? Settlement discounts materialise when we receive money from payables right? Or, am I wrong to think so?
Could you also give me the double entry for when Kyles pays his dues, as in the question. i.e without taking the benefit of settlement discount?
I am afraid that your lecturer is wrong (and he cannot have had it confirmed by the examiner, because it is not true!!)
The tax law is that the sales tax is calculated after subtracting all discounts.
The settlement discount is not accounted for at the time of raising the invoice – it is only taken into account in calculating the sales tax.
If the customer does not take the discount (because they do not pay within the required period) then the tax is not re-calculated, and they will effectively have paid less that the full rate of sales tax.
However, that is not really much of a problem because settlement discounts are more likely to be between businesses, and the tax charged by one business is the tax suffered by the the other business – so it does not affect the tax authorities overall.
Also, the law is that the discount must be a ‘commercial discount’. What they mean is that you cannot offer ridiculous settlement discounts just as a way of trying to avoid tax.
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