What type of company would normally offer trade discounts to its customers?

What is a Trade Discount?

Trade discount refers to the reduction in list price known as a discount, allowed by a supplier to the consumer while selling the product generally in bulk quantities to the concerned consumer to increase the sales of the business as more customers are attracted when the discount is given on the list price of the product.

In simple words, a Trade discount is a discount that is referred to as a discount given by the seller to the buyer at the time of purchase of goods. It is given as a deduction in the list price or retail price of the quantity sold. This discount is usually allowed by the sellers to attract more customers and receive the order in bulk, i.e., to increase sales. Thus, no record is to be maintained in the books of accounts of both the buyer and seller.

• It is a discount allowed on a product as a reduction to the retail price. It is the amount by which a manufacturer or wholesaler reduces the price of a product when it sells the product to a reseller.
• Trade discount usually varies with the quantity of the product purchased. It is a reduction in the published price of the product.
• For example, a high-volume wholesaler might be entitled to a higher discount than a medium or low-volume wholesaler.
• Usually, a retail customer will not receive any discount and must pay the entire published price.

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Source: Trade Discount (wallstreetmojo.com)

Accounting Treatment

The sale and purchase will be recorded at the amount after the trade discount is subtracted. As this discount is deducted before any exchange takes place, it does not form part of the accounting transaction and is not entered into the business’s accounting records.

Key Points

• It is usually allowed to facilitate bulk sales.
• It can generally be allowed for all customers who want to purchase bulk.
• In the case of Trade discounts, there is no entry made in the books of accounts of the buyer and seller.
• It is always deducted before any type of exchange takes place. Hence, it does not form part of the books of business accounts.
• It is usually allowed at the time of purchase.
• It usually differs from the number of goods purchased and purchased.

Head-to-Head Differences Between Trade Discounts vs. Cash Discounts

Trade Discount vs. Cash Discount Journal Entry

Mr. X purchased goods from Mr. Y for a list price of $8000 on April 1st, 2018. Mr. Y allowed a 10% discount to Mr.X on the list price for purchasing goods in bulk quantity. Further, a discount of $500 was allowed to him for making an immediate payment.

• Firstly, the discount allowed on the list price of the goods, i.e., 10% of $8000 = Rs. 800 is a trade discount, which will not be recorded in the books of accounts.
• Next, the discount received by Mr.X of $500 for making the immediate payment is a cash discount, and it is allowed on the invoice price of the goods. The cash discount is to be recorded in the books of accounts.

The journal entry in the books of Mr.X is:

Trade discount is given on the list price or retail price of the goods.

Conclusion

The final objective of every organization is to increase sales revenueSales revenue refers to the income generated by any business entity by selling its goods or providing its services during the normal course of its operations. It is reported annually, quarterly or monthly as the case may be in the business entity's income statement/profit & loss account.read more, and the trade discount is the primary tool to achieve it. However, a cash discount is also a tool used to achieve the organization’s objectives. Usually, the customers have the habit of bargaining and giving them these discounts; it enables a firm to achieve its objectives and retain the customer. Thus, it will be favorable for both the customer and the organization.

As we discussed above, it increases the purchase quantities. It also increases the credit riskCredit risk is the probability of a loss owing to the borrower's failure to repay the loan or meet debt obligations. It refers to the possibility that the lender may not receive the debt's principal and an interest component, resulting in interrupted cash flow and increased cost of collection.read more of the organization. On the other hand, it does not affect the organization’s profit margin as it is not recorded in the books of accounts, but more and more cash discountsCash discounts are direct incentives and discounts provided by any company to their customers in exchange for paying their bills on time or before the due date. This is a common practice, and the discount may differ from one company to the next depending on the terms and conditions.read more decrease the firm’s profit margin. Hence, both the discounts have advantages and certain disadvantages that need to be taken care of while giving discounts.

Trade Discount Video

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