Why trade discount is not recorded in the books of accounts

What is a Trade Discount?

Trade discount refers to the reduction in list price known as a discount, allowed by a supplier to the consumer while selling the product generally in bulk quantities to the concerned consumer to increase the sales of the business as more customers are attracted when the discount is given on the list price of the product.

In simple words, a Trade discount is a discount that is referred to as a discount given by the seller to the buyer at the time of purchase of goods. It is given as a deduction in the list price or retail price of the quantity sold. This discount is usually allowed by the sellers to attract more customers and receive the order in bulk, i.e., to increase sales. Thus, no record is to be maintained in the books of accounts of both the buyer and seller.

  • It is a discount allowed on a product as a reduction to the retail price. It is the amount by which a manufacturer or wholesaler reduces the price of a product when it sells the product to a reseller.
  • Trade discount usually varies with the quantity of the product purchased. It is a reduction in the published price of the product.
  • For example, a high-volume wholesaler might be entitled to a higher discount than a medium or low-volume wholesaler.
  • Usually, a retail customer will not receive any discount and must pay the entire published price.

Trade Discount

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For eg:
Source: Trade Discount (wallstreetmojo.com)

Accounting Treatment

The sale and purchase will be recorded at the amount after the trade discount is subtracted. As this discount is deducted before any exchange takes place, it does not form part of the accounting transaction and is not entered into the business’s accounting records.

Key Points

  • It is usually allowed to facilitate bulk sales.
  • It can generally be allowed for all customers who want to purchase bulk.
  • In the case of Trade discounts, there is no entry made in the books of accounts of the buyer and seller.
  • It is always deducted before any type of exchange takes place. Hence, it does not form part of the books of business accounts.
  • It is usually allowed at the time of purchase.
  • It usually differs from the number of goods purchased and purchased.

Head-to-Head Differences Between Trade Discounts vs. Cash Discounts

Basis For ComparisonTrade Discount Cash Discount MeaningA discount given by a seller to the buyer as a deduction in the list price of the commodity is a trade discount.A reduction in the amount of invoice allowed by the seller to the buyer in return for immediate payment is a cash discount.PurposeTo facilitate sales in bulk quantity.To facilitate prompt payment.When allowed?At the time of purchase;At the time of payment;Entry In BooksNoYes

Trade Discount vs. Cash Discount Journal Entry

Mr. X purchased goods from Mr. Y for a list price of $8000 on April 1st, 2018. Mr. Y allowed a 10% discount to Mr.X on the list price for purchasing goods in bulk quantity. Further, a discount of $500 was allowed to him for making an immediate payment.

  • Firstly, the discount allowed on the list price of the goods, i.e., 10% of $8000 = Rs. 800 is a trade discount, which will not be recorded in the books of accounts.
  • Next, the discount received by Mr.X of $500 for making the immediate payment is a cash discount, and it is allowed on the invoice price of the goods. The cash discount is to be recorded in the books of accounts.

The journal entry in the books of Mr.X is:

Trade discount is given on the list price or retail price of the goods.

DateParticularsL.F.Debit AmountCredit Amount1-Apr-18Purchase A/c Dr.7200To Cash A/c6700To Discount Received A/c500(Being goods purchased from Mr. Y worth Rs. [email protected] 10% trade discount and cash discount of Rs. 500)

Conclusion

The final objective of every organization is to increase sales revenueSales RevenueSales revenue refers to the income generated by any business entity by selling its goods or providing its services during the normal course of its operations. It is reported annually, quarterly or monthly as the case may be in the business entity’s income statement/profit & loss account.read more, and the trade discount is the primary tool to achieve it. However, a cash discount is also a tool used to achieve the organization’s objectives. Usually, the customers have the habit of bargaining and giving them these discounts; it enables a firm to achieve its objectives and retain the customer. Thus, it will be favorable for both the customer and the organization.

As we discussed above, it increases the purchase quantities. It also increases the credit riskCredit RiskCredit risk is the probability of a loss owing to the borrower’s failure to repay the loan or meet debt obligations. It refers to the possibility that the lender may not receive the debt’s principal and an interest component, resulting in interrupted cash flow and increased cost of collection.read more of the organization. On the other hand, it does not affect the organization’s profit margin as it is not recorded in the books of accounts, but more and more cash discountsCash DiscountsCash discounts are direct incentives and discounts provided by any company to their customers in exchange for paying their bills on time or before the due date. This is a common practice, and the discount may differ from one company to the next depending on the terms and conditions.read more decrease the firm’s profit margin. Hence, both the discounts have advantages and certain disadvantages that need to be taken care of while giving discounts.

Trade Discount Video

 

This article has been a guide to what is Trade Discount? Here we discuss the Trade Discount definition, accounting treatment, journal entries along with examples, and also its difference with Cash Discount. You may also have a look at the following articles:-

Discounts are commonly used for business promotions. They are often used to sweeten the deal between a buyer and a seller. Discounts reduce the asking price of a particular product or service.

Meaning of trade discount and purpose

Manufacturers often prepare product catalogues for wholesalers, retailers and other resellers. These product catalogues will contain the listed prices of the products. However, when a reseller offers to buy the product in bulk, the manufacturer reduces the listed price of the product. This is called a trade discount. 

Trade discounts are often given based on good manufacturer-buyer relationships or in the event of bulk orders.

Calculation of trade discount with examples

Wholesalers tend to get better trade discounts since they buy products in bulk.

For instance, CS Ltd wishes to buy 200 guitars from GB Ltd. The list price of the guitars stands at Rs.2,000 per piece. GB Ltd offers a trade discount of 25% considering the size of the deal. The trade discount amounts to Rs. 500 per guitar (Rs.2,000 * 25%).
CS Ltd now gets the guitars at Rs.1,500 per piece on purchase.

GST laws on the treatment of trade discount

The GST laws state that there will be no difference in trade discounts and cash discounts. Where a discount is mentioned on the invoice’s face, the discount may be reduced from the taxable value of the supply of goods.

In the event the discount is not mentioned on the face of the invoice, the discount may still be reduced if-

  • The supplier and the buyer have entered into an agreement that includes a provision about the discount factor.
  • The discount is linked to a specific invoice.
  • Any input tax credit attributable to the discount must be reversed by the buyer or recipient of the supply.

Accounting of trade discount

Trade discounts are usually based on the list price (catalogue price). Sales are recorded based on net price. Net price = List price – Trade discount. Therefore, trade discounts are not recorded in the books of accounts.

However, on the other hand, cash discounts are recorded in the books of accounts. Cash discounts are usually allowed on the invoice price of the goods.
Example: PVS Ltd places an order for 15 shirts with DVS Ltd. The list price of the shirts is Rs.500 each. The trade discount applicable is 10%. DVS Ltd allows them a further discount of Rs.1,000 if the payment is made immediately. PVS Ltd chooses to make an immediate payment.

List price (15*500) 7,500

(-)Trade discount @ 10%   (750)

Net price 6,750

In the books of PVS Ltd, the following entry is made:

Purchases A/c ……….. Dr 6,750

     To Discount Received A/c 1,000

      To Cash A/c 5,750

(Being goods purchased from DVS Ltd worth Rs.7,500 upon which
there was a 10% trade discount and cash discount of Rs.1,000)

Trade discount in invoice

trade discount

Comparison between trade discount and cash discount

Edit Trade DiscountCash Discount Reduction is given in the list price (catalogue price) of the goods by the manufacturer to the wholesalerAllowance is given to the customer by the seller on the invoice price of the goods if the payment is made immediately Given as a result of common trade practices, especially where bulk deals take placeGiven as an incentive for early or immediate payment Usually a fixed percentagePercentage may or may not be fixed Based on the quantity factor (size of the purchase)Based on the time factor (period of payment) Transaction may be on credit or a cash basisOnly on a cash basis Reduction is made on listed price (catalogue price)Reduction is made on the invoice price Given to promote salesGiven to recover payments quickly

ClearOne provides several validations to ensure that you report discounts accurately in the invoices.

Written by Jane