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. By varying the level of trade discount 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 a Trade Discount
The trade discount is simply used to calculate the net price for the customer. As the trade-discount is 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%, then the customers price is calculated using the trade discount formula 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
The 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:
The only bookkeeping entry relates to the net price (840) given to the customer. The list price of 1,200 and the trade discount of 360 (1,200 x 30%) are not entered into the accounting records.
What is the Difference Between Trade Discount and Cash Discount
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.
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.
If in the above example, a cash discount of 5% had been given for payment within 30 days, then providing payment is made on time, the customer would deduct a cash discount of 5% x 840 = 42 when making payment.
It should be noted 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.
The difference between a trade discount and a cash discount is summarized in the diagram below.
The bookkeeping entry to record the payment by the customer would then be as follows.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.