Chapter 9
Discounts and Rebates
Vendors may offer discounts for early payment of invoices. Rather than borrowing money to finance operations, vendors are often willing to receive a smaller amount of money in exchange for being paid quickly. When vendors offer discounts, it is up to the government paying office to determine whether paying early is economically justified and whether the office can make the payment by the discount deadline.
109. What does the notation “.5/10 Net 30” mean?
This is how discounts are normally stated. In this example, it means, “If you pay this invoice within ten days, you may take a 0.5 percent discount. If you fail to pay within ten days, the entire (net) amount is due within 30 days.” The ten days is referred to as the “discount period,” and the 0.5 percent is called the “discount rate.”
110. If the contract terms state “Net 30,” and the invoice offers a discount (e.g., .5/10 Net 30), may I take the discount, or do the contract terms prevail?
You may take the discount. The rule states that the government may go with the most favorable terms offered. Because the invoice offers more favorable terms (the flexibility to take a discount), it is acceptable to take the discount.1
111. What if the contract says “Net 30,” and the invoice says “.5/10 Net 20”?
You may pick the most favorable terms offered. You may take the dis count, paying within ten days. But if you don’t take the discount, you would make the net payment under the Net 30 terms, as those are more favorable to the government.
112. Should I take every discount that is offered?
No. Only discounts that are economically justified should be taken.2
113. How can I determine if a discount is economically justified?
The agency must calculate the effective annual interest rate (EAIR) and compare it with the current value of funds rate (CVFR). If the EAIR is greater than the CVFR, the discount is economically justified. If the EAIR is less than the CVFR, the discount should be refused and a net payment should be made.3
114. What is the effective annual interest rate?
The EAIR is the rate of return the government earns if it takes a discount. When it takes a discount, the government releases funds 20 to 25 days early to the vendor. The discount is compensation for this early release of funds. It is similar to making a loan. Think of the discounted payment to the vendor as money “loaned” for a 20- to 25-day period. The discount is the “interest” earned by the government in exchange for the early payment. The EAIR is simply a conversion of the discount rate to an annual rate, based on the number of days early that a payment is made.
115. How do I calculate the EAIR?
The Treasury provides the following formula in its Treasury Financial Manual.4
Here’s an example: An invoice dated June 15 is date-stamped on June 19. It offers discount terms of 1/10 Net 30. The discount percentage is 1 percent. “Annual calendar days” is a constant 360 days. There are 30 days in the payment period. “Days left in discount period” is six (ten days in the discount period, less the four days’ difference between the date on the invoice and the receipt of the invoice).
Putting these variables into the formula results in the following:
116. Can you explain the logic of the EAIR formula?
The left side of the formula is fairly self-explanatory, but the right side requires some explanation. The idea is to annualize the number of days early the payment is being made.
By convention, a year is assumed to have 12 months of 30 days each, thus the constant of 360 days in the year. The denominator represents the number of days early that the payment is being made. If the vendor’s invoice date is the same as the date stamp, then the invoice will be paid early by the number of days allowed for a net payment less the number of days in the discount period. A Net 30 invoice with a discount period of ten days would thus be paid 20 days early.
On the other hand, if the vendor’s invoice date is earlier than the date stamp, as in the example above, the invoice will be paid even sooner than 20 days early. This is because the discount period starts with the invoice date, while the net payment period starts with the date-stamp date. In the example above, the discounted payment must be made by June 25 (ten days after June 15), while the net payment isn’t due until July 19 (30 days after June 19). So, if the discount is taken, the invoice will be paid 24 days early.
117. Now that I’ve calculated the effective annual interest rate, what can I do with it?
You can compare the EAIR with the current value of funds rate (CVFR). If the EAIR is greater than the CVFR, you will try to take the discount. Otherwise, you will refuse the discount.
118. What is the current value of funds rate?
The CVFR is based on the investment rates for the Treasury tax and loan accounts. The Treasury averages investment rates for the 12-month period ending on September 30, rounded to the nearest whole percentage. The Treasury’s Financial Management Service (FMS) publishes the rate at least annually in the Federal Register and in a bulletin, normally at the end of October, with an effective date of January 1.5 During times of extreme interest volatility, if the rate changes by 2 percent or more from the prior quarter, the CVFR is subject to quarterly revision.
119. Where can I find the CVFR?
The Treasury issues a bulletin annually that lists the CVFR for the following calendar year. It can be found at www.fms.treas.gov/cvfr/index.html. The latest Treasury bulletin is in Appendix 6 of this book.
120. How do I calculate the due date for a discount payment?
The due date for a discount payment is the vendor’s invoice date plus the discount period.6
121. If the vendor doesn’t date its invoice, what should I use as the start date for the discount period?
Use the date the invoice is actually received and date-stamped or otherwise annotated by the designated agency office.7
122. If the due date falls on a weekend or federal holiday, may I pay on the next business day and still properly take the discount?
Yes, so long as the payment date is the next business day, the discount is proper.8
123. What if I receive an invoice a week after the vendor dates it?
If the invoice has a ten-day discount period, that means you have only three days to make payment if you are to take the discount. Depending on your payment processes, that may be impossible.
124. My agency wants all discounts taken; we’ve been told to never refuse a discount. Is that good guidance?
While it is understandable that an agency would like to capture all available discounts because they free up funds for other program purposes, such guidance ignores the cost to the Treasury to borrow funds to make early payment. This is contrary to the intent of the Prompt Payment Act and the specific direction in the Final Rule stating that agencies will take discounts if they are economically justified.
125. My agency has a discount threshold of $25.00. The direction states that discounts of less than $25.00 need not be taken, with the rationale that they are not worth the effort. Is that guidance in keeping with Prompt Payment rules?
This question is not specifically addressed in the Prompt Payment rules. The Final Rule simply states that “an agency may take the discount if economically justified” and refers to the discount formula in the Trea sury Financial Manual. From a strict reading of the rule that an agency “may,” not “must,” take the discount, it would appear that agencies have the discretion to set a threshold for refusing discounts.
However, the Treasury Financial Manual directs that agency payment systems will incorporate procedures that take advantage of cash discounts as a matter of routine and that eliminate any need for special handling. If an agency has a payment system that can take discounts routinely without special handling, the justification for a discount threshold is obviated. On the other hand, if an agency has calculated that the average level of effort to take a discount costs $25.00, the agency’s position can be economically justified.
The intent of the rule is for agencies to take discounts if it is economically advantageous. Agencies would be foolish to arbitrarily set a threshold higher than their cost of taking discounts, although it is within their administrative discretion to be foolish.
126. What sort of data should an agency collect to monitor its performance in taking discounts?
Some agencies simply divide the number of discounts taken by the number of discounts offered to calculate a percentage of discounts taken. Those not taken are considered discounts lost.
It is better to use some variation of the following method:
Count the entire population of discounts offered.
Stratify this population into three categories:
Discounts taken
Discounts refused because they were not economically justified
Discounts impossible to take because invoices were received late.
Any discounts that do not fit into one of these categories would be discounts lost (discounts that should have been taken). Discounts refused and discounts impossible to take should not detract from a paying office’s performance rating.
Compute the number of discounts taken and discounts lost as a percentage of the population of justifiable discounts.
For example, assume the population of discounts offered is 1,000. Six hundred of these were taken, 75 were refused, and 225 were impossible to take. Of the 1,000 discounts offered, 100 do not fall into one of these categories. Those are the discounts lost. Thus, the number of justifiable discounts is 700 (1,000 less 75 less 225). This would mean 100 of 700 justifiable discounts were lost, for a lost-discount rate of 14 percent. Compare that with a 40 percent lost-discount rate using the first method (600 discounts taken, 400 not taken). The rate of 14 percent is a more accurate measure of the paying office’s performance.
127. Is it permissible to make a payment without verifying acceptance in order to take a discount?
The desire to take a discount is not a justification to ignore the rules stating that acceptance must take place prior to payment.
128. If a discount has been taken improperly, after the discount period, what is the proper course of action?
When a discount has been taken late, the agency should send the vendor another payment representing the difference between the full cost and the discount cost, plus any interest penalties accrued on the amount of the discount.
129. What are rebates, and how are they similar to discounts?
Rebates are monetary incentives offered by the issuers of government- wide commercial purchase cards to the government to pay purchase card invoices early. They are similar to discounts in that early payment of a purchase card invoice results in a reduction in the amount of money ultimately paid to the card issuer. The card issuers offer rebates for the same reason vendors offer discounts on commercial invoices: because of the time value of money.
The difference between a rebate and a discount is simply one of timing. Discounts are taken at the time of payment, as a reduction in the amount disbursed. Rebates come after the fact. The entire amount of the invoice is paid, and the rebate is returned to the government in the form of a refund at a later date.
130. Is the same calculation that is used to determine whether to take a discount also used to determine when to pay early to get a rebate?
The concept is the same: The return the government will get by paying early is compared with the CVFR. However, card issuers typically structure their rebates on the basis of daily basis points. The agency’s contractwith the card issuer will specify the number of daily basis points it offers. One hundred basis points represents 1 percent.
For example, if 1.5 daily basis points are offered to an agency by the card issuer, that means for every day the agency delays paying the card issuer, the agency loses 1.5 basis points in savings. This contractual rate of 1.5 basis points is compared with the average daily basis points of the CVFR, which is calculated by dividing the CVFR by 360 and multiplying by 100 ((CVFR/360) * 100 = average daily basis points of the CVFR). Assuming a CVFR of 5 percent, the CVFR has 1.4 daily basis points (5/360 * 100 = 1.4). Thus, the government earns 1.4 basis points for every day it delays payment. Because the card issuer offers 1.5 basis points, which is more than the 1.4 basis points the government earns for delaying payment, the government should try to pay this invoice as early as possible.
If the CVFR were 6 percent, the basis points of the CVFR would equal 1.67 (6/360 * 100 = 1.67). In this instance, because the rate offered is lower than the CVFR rate, the government should minimize costs by paying as late as possible—but by the payment due date.9
131. Is there a resource available to help determine whether rebates should be taken?
Agencies may use a rebate spreadsheet that automatically calculates the net savings to the government, showing whether the agency should pay early or on time. The only variables required for input into the spreadsheet are the CVFR; the maximum discount rate, that is, the rate from which the number of daily basis points offered by the card issuer is derived; and the amount of the debt. This spreadsheet is available for use on the Prompt Payment website at http://fms.treas.gov/prompt/rebate.html.10
132. Are rebates that come back from card issuers credited back into the agency’s appropriation?
Yes, they are considered refunds and return to the appropriation from which they were disbursed. This can create an unfortunate situation: Funds about to expire in September may be used to pay a bill, but the rebate comes back to the agency in October or November. The rebate must be credited back to the now-expired appropriation. Such rebates are therefore no longer available for new obligations.
Recognizing the substantial loss of funds created by this situation, the Department of Defense requested legislation that would allow rebates to be credited to appropriations current at the time the rebates are received. Congress gave DoD this authority on a year-by-year basis for several years in its annual appropriations act. The FY2008 DoD Appropriations Act made this provision permanent. As of this writing, only DoD has such authority. All other agencies must credit these after-expiration rebates back to the expired accounts.
NOTES
1. Office of Management and Budget, § 1315.7(a).
2. Ibid.
3. U.S. Department of the Treasury, Treasury Financial Manual, 1: § 8040.40.
4. Ibid.
5. Ibid., § 8020.
6. Office of Management and Budget, § 1315.7(d).
7. Ibid.
8. Government Accountability Office, Chapter 12, 12-239.
9. Office of Management and Budget, § 1315.17.
10. Ibid., § 1315.17(2).