Trade Discount - What Is It, Formula, Vs Cash Discounts (2024)

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 trade discount rate 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.

Trade Discount Explained

Trade discount is a reduction 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.

The final objective of every organization is to increase sales revenue, 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, using a trade discount calculator increases the purchase quantities. It also increases the credit risk 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 discounts 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.

Formula

The formula to calculate the trade discount rate is discussed below. It acts as the very basis for our calculations and understanding of the concept and its related factors.

Trade Discount = List Price × Trade Discount Rate

Where,

• List Price is the original or undiscounted price of the product or service.
• Trade Discount Rate is the percentage of discount offered by the seller.

Examples

Now that we understand the fundamentals of the concept, let us understand how to use a trade discount calculator with the help of a couple of examples as discussed below.

Example #1

The list price of a product is $1,000 and the trade discount rate is 15%, it would be:

Trade Discount = $1,000 × 0.15 = $150

This means the buyer would receive a discount of $150 on the product, resulting in a final price of $850 ($1,000 - $150).

It's important to note that the trade discount is applied before any other calculations, such as taxes or additional discounts.

Example #2

Ever since Russia declared war against Ukraine in 2022, major countries across the globe took drastic steps to cut ties with the oil rich country. However, a few eastern countries continued buying the now-discounted Russian crude oil.

In 2023, Russia remained China’s largest supplier of crude oil. Their purchase went up 13% in comparison to the previous year to 1.9 million barrels a day.

Their purchase remained steady despite the discounts shrinking from $8.5 per barrel to $5-$6 per barrel.

Accounting Treatment

The sale and purchase will be recorded at the amount after the 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.

Trade Discount in Video

Trade Discounts vs. Cash Discounts

Let us understand the key differences between trade discount rates and cash discounts through the head-to-head comparison below.

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.

Recommended Articles

This article has been a guide to what is Trade Discount. Here we explain its formula, examples, and accounting treatment, and compare it with cash discounts. You may also have a look at the following articles:-

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