In accounting, a trade discount is a reduction in price a manufacturer or wholesaler offers a trade buyer on the list price of goods.
Offering trade discounts is a standard practice in many sectors as a means of encouraging clients to make greater purchases or to develop long-term business partnerships.
Purpose of Trade Discounts
The purpose of a trade discount is to encourage the reseller to purchase a larger quantity of the manufacturer’s or wholesaler’s products. A trade discount is different from a sales discount, which is a reduction in price offered to the customer by the reseller. Trade discounts are not recorded in the accounting records of the reseller, while sales discounts are.
The size of the trade discount offered depends on the quantity of the goods purchased and the relationship between the manufacturer or wholesaler and the reseller. For example, a manufacturer may offer a higher trade discount to a reseller who purchases a large quantity of goods.
The trade discount is deducted from the list price of the goods when the reseller calculates its cost of goods sold (COGS). The trade discount is not recorded as an expense in the accounting records of the reseller.
Trade discounts are distinct from cash discounts, it’s vital to remember that. Cash discounts are given to consumers who pay for their products on time, whereas trade discounts are more concerned with the quantity or type of business done.
In accounting, trade discounts are treated as reductions in the revenue earned by the seller, which ultimately impacts the gross profit margin. This reduction is not recorded as a separate expense or income, but rather as an adjustment to the selling price. The use of trade discounts allows businesses to attract customers and remain competitive in the market while also influencing their financial statements.