All businesses give discounts to their customers in order to increase the sales of their products. Discounting reduces the selling price of a product, making it more appealing to the customer. The two most commonly offered discounts are – trade discounts and cash discounts.
What is a trade discount?
A trade discount is a deduction on the list (or catalogue) price allowed by manufacturers or wholesalers. When manufacturers sell goods to wholesalers or when wholesalers sell goods to retailers, they normally allow a trade discount for various reasons. Such a discount is given by suppliers to purchasers as a token of doing business with them. The rate of trade discounts can vary considerably from one supplier to another.
The objective of offering a trade discount is to increase product sales and give customers the impression that they are getting the best deal possible.
Trade discount is allowed at what price?
Trade discount is charged on the list price of goods and services.
How is trade discount recorded in the books of account?
From an accounting point of view, trade discount is not recorded in the books of account. No entries are made in the seller’s books or purchaser’s books for the recording of such a discount.
Transactions of sale and purchase are recorded at the net invoice price, i.e., after deducting the value of trade discount from the list price.
In the books of the seller, the journal entry is:
Debtor’s A/c – Debit (With the invoice price)
To Sales A/c – Credit
The journal entry in the books of the purchaser is:
Purchases A/c – Debit (With the invoice price)
To Creditor’s/Supplier’s A/c – Credit
Note: Although no accounting entry is recorded for trade discount, it is shown by way of a deduction in the invoice.
Example of trade discount
Suppose a wholesaler sells furniture to a retailer for a list price of $15,000. He allows a 20% trade discount thereof to the retailer on account of doing business with him. The retailer gets the furniture at $12,000 which is $15,000 minus trade discount of $3,000 ($15,000 × 20%). Eventually, the retailer expects to sell it finally to the customer at the list price of $15,000 thereby making a profit.
Both the wholesaler and retailer do not record this trade discount in their books. Although the invoice mentions a detail of this trade discount, the transaction gets recorded at the invoice price of $12,000 in this manner:
What is a cash discount?
A cash discount is granted and received for prompt payment. This discount is allowed by a seller of goods/services to the purchaser at the time of making payment for the purchase. When a customer is granted a cash discount, a lower amount is accepted as full payment of a debt. Likewise, when a cash discount is received, a lower amount is paid in full discharge of a liability.
A cash discount is given to customers or buyers in order to get them to pay for the product as soon as possible, which helps the business reduce or avoid credit risk entirely.
‘Cash discount’ is allowed at what price?
A cash discount is charged on the invoice price of goods and services. This is the list price less any trade discount already allowed.
How is cash discount recorded in the books of account?
A proper recording is done for cash discount both at the buyer’s and supplier’s end.
The amount of discount allowed is debited to the “discount allowed” account, cash received is debited to “cash account” and the total amount is credited to the debtor making the payment. This is done in the books of the seller.
The journal entry is:
Discount allowed A/c – Debit (With the amount of discount)
Cash A/c – Debit (With the amount of cash received)
To Debtor’s A/c – Credit (With the total invoice price settled)
Similarly, in the books of the purchaser, the amount of discount received is credited to the “discount received” account. The amount of cash paid is credited to Cash Account and the sum of the two is debited to the creditor to whom the payment is made.
The journal entry is:
Creditor’s A/c – Debit (With the total invoice price)
To Cash A/c – Credit (With the amount of cash paid)
To Discount Received A/c – Credit (With the amount of discount)
Example of cash discount
Continuing our discussion with the above example of furniture, let’s say the wholesaler offers another 2% cash discount to the retailer if he happens to settle the payment of his account within 15 days. The wholesaler wants to expedite the collection process and so this 2% discount is a win-win deal for both parties. On one hand, the wholesaler receives prompt payment and on the other, the retailer enjoys a further 2% discount on the purchase.
To settle his account, the retailer pays $11,760 which is $12,000 minus $240 ($12,000 × 2%). The percentage of cash discount is always computed on the list price less any trade discount already availed, which in this case, is $12,000 ($15,000 – $3,000).
To record this cash discount, the following entries are made in the wholesaler’s and retailer’s books:
Comparison table – Difference between trade discount and cash discount
The table below shows a list of differences between the two types of discounts:
|Basis of difference||Cash Discount||Trade discount|
|Meaning||It is a discount granted by a supplier from the invoice price in exchange for immediate or prompt payment.||It is a discount granted by a supplier from the list price of goods or services in exchange for business consideration.|
|Objective||A cash discount is given in order to encourage timely payment.||A trade discount is given to promote sales or increase revenue.|
|Invoice||It is not displayed in the invoice.||It is displayed in the invoice as a way of deduction from the list price.|
|Separate account||A separate discount account is opened in the ledger to record the amount of discount received or allowed.||No such account is opened in the ledger to record trade discounts.|
|Allowed when||A cash discount is allowed on payment of money for goods or serviced purchased.||A trade discount is allowed at the time of purchase of goods or services.|
|Variability||The rate of cash discount can vary with the time period within which payment is released. Quick payments by the buyer attract greater discounts.||The rate of trade discount can vary with the quantity of goods acquired or the value of purchases effected. Suppliers usually give heavy discounts on bulk purchases.|
|Transactions||Applicable to cash transactions||Applicable to both cash and credit transactions|
Both cash discounts and trade discounts are tools to boost sales in a business. They are a form of incentive given to customers so that frequent purchases are made by them. While trade discount is a way of reduction in the list price of products offered, cash discount further reduces the net payment value. Cash discount accelerates the collection process of debts whereas trade discount helps in improving sales.