Trade Discount

To avoid having to publish numerous different price lists, it is common for a business to quote a singe list price for each of its products and then offer customers a reduction in the price by way of a trade discount. Consequently by varying the level of trade discounts the business can change the price given to different customers. For example, a retail customer might be charged the full list price, whereas a customer who purchases products in large volumes might be given a large trade discount and a lower price.

Accounting for Trade Discounts

As can be seen trade discounts are simply used to calculate the net price for the customer. As trade discounts are deducted before any exchange takes place, it does not form part of the accounting transaction, and is not entered into the accounting records of the business.

For example, suppose a business sells a product with a list price of 1,200 and offers a trade discount rate to a customer of 30%.  Accordingly the calculation of the customers price using the trade discount formula is as follows:

List price = 1,200
Trade discount = 30%
Price after discount = List price x (1 - Trade discount %)
Price after discount = 1,200 x (1 - 30%)
Price after discount = 840

Accordingly the financial exchange will now take place at a price of 840 and, assuming the customer has credit terms with the business, the bookkeeping entry would be as follows:

It is important to realize that the only bookkeeping entry relates to the net price (840) given to the customer. There is no entry in the accounting records for both the list price of 1,200 and the trade discount of 360 (1,200 x 30%).

Trade Discount Double Entry

Trade discounts and cash discounts are both types of sales discounts. A trade discount is deducted before any exchange takes place with the customer and therefore does not form part of the accounting transaction, and is not entered into the accounting records. Consequently there is no trade discount journal entry.

In contrast to this a cash discount or early settlement discount is given after the exchange with the customer, and therefore is entered into the accounting records.

To illustrate suppose in the above example, a cash discount of 5% is given for payment within 30 days. Providing payment is made on time, the customer deducts a cash discount of 5% x 840 = 42 before paying.

It is important to realize that the cash discount is based on the customers invoiced price of 840 (after the trade discount) and not on the original list price of 1,200.

Additionally the diagram below summarizes the difference between trade discounts and cash discounts.

The bookkeeping entry to record the payment by the customer would then be as follows.