Trade discounts are discounts given to customers who purchase goods or services in large quantities or on a regular basis.
These discounts are meant to encourage customers to buy more from the seller, and they are often a percentage of the list price.
In this blog post, we will explain what trade discounts are and how they are treated in the books of accounts.
What is a Trade Discount?
A trade discount is a reduction in the list price of goods or services a seller offers its customers. The discount is based on the quantity of goods or services purchased, the frequency of purchases, or any other factors that the seller considers. Trade discounts are also known as functional discounts, volume discounts, or quantity discounts.
For example, a manufacturer of electronic products may offer a 10% trade discount to a retailer who purchases more than 100 units of a specific product. The trade discount allows the retailer to sell the product at a lower price while maintaining a reasonable profit margin. On the other hand, the manufacturer benefits by selling a large quantity of goods.
Treatment of Trade Discount in Books of Accounts
Trade discounts are not recorded as separate transactions in the books of accounts. Instead, they are treated as a reduction in the purchase or sales price of the goods or services.
For example, if the list price of a product is $100, and a 10% trade discount is offered, the invoice price would be $90 ($100 – $10).
Trade Discount vs Cash Discount
Cash discounts are intended to encourage the buyer to make the payment of bills in a timely manner. They are extended to any buyer, either their wholesale or retail level, and are subject to payment within a stated time frame. The cash discount is given after the purchase is made and is shown as a discount from the amount due.
In contrast to trade discounts, cash discounts are accounted for differently in the accounts, either as a sales discount (from the seller’s side) or a purchase discount (from the buyer’s side). For example, a seller may give a 2% cash discount if the buyer settles the invoice within 10 days.
In short, trade discounts encourage what a buyer buys, whereas cash discounts encourage when they pay. It is also the case that the two kinds of discounts can be given together, creating stacked incentives for both volume buying and up-front payment.
