In the business world while selling goods or services the price charged is often lesser than the list, retail or quoted price and the amount by which the price is reduced is called discount. And as this discount is offered at the time of trade therefore trade discount. Another lesser known name of trade discount is functional discount.
One of major reasons to offer such discounts to buyer is to strike a deal i.e. to sell goods by making them even more attractive by reducing prices. Bulk order discount is one of the most popular examples of trade discount where buyer is offered reduced per unit prices if order size exceeds by specific number of units.
Trade discount, as the name suggests, is offered to buyers at the time of trade i.e. when goods are changing hands. The amount of transaction is net of trade discount i.e. amount at which purchase is recorded by the buyer will be the amount from discount has already been deducted. Same is the case with the sale recorded by the seller. For example, if a product has a retail price of $100 and trade discount offered is $15 then the accounting entries in the books of buyer and seller will be as follows:
Accounting entry in the books of purchaser/buyer:
|Dd/mm||By Purchases a/c||85|
|To Cash a/c||85|
|Goods purchased on cash for $85|
Accounting entries in the books of seller/supplier:
|Dd/mm||By Cash a/c||85|
|To Sales a/c||85|
|Goods sold for cash $85|
One thing to notice in the above accounting entries is that no record of trade discount is made while recording journal entries. The only record of trade discount we can have is on the face of invoice i.e. the source document of the sale/purchase transaction.
The reason why no record of trade discount is maintained is that it is against the economic reality of the transaction. A person owes only what he had bought things for and what he has bought for is net of discount. The discount that strike the deal and caused the trade to happen. Another reason why trade discount is given no accounting treatment is that it is offered before ownership of the goods has been transferred. A transaction is recorded on such amount on which trade has taken place or ownership has changed hands. And this is evident from the accounting entries in the example discussed above.
As mentioned earlier it is only recorded on the face of invoice and thats all. It is invoice that tells the amount at which sale/purchase should be recorded and the amount is called invoice price which is basically a net result of retail price and trade discount. A sample invoice of our above example may look like this:
Trade discount may be associated with the retail price (also known as list price or quoted price). If it is offered in connection with the quoted price then it is mentioned as a percentage however, it can also be a specific amount agreed between the parties to the transaction just like in our example if it was associated with the list price then discount would have been mentioned as 15% of the retail price.
Speaking in strict accounting terms, as trade discount is not recorded in the books of accounting, their effect on the profits of the entity cannot be measured. The only way to conduct such analysis is to have the invoices available as only invoices record the amount of trade discounts offered. Usually entities instruct the sales team about the extent to which trade discount can be offered to the customer to make the sales and that figure is measured keeping the profitability of the product in mind.
One of the major implications or usage of trade discount is observed in the sale transactions between wholesaler and retailer. Retail price is mentioned by the manufacturer which practically limits the price of the product and keep anyone in the supply chain to effectively alter it as customer will not be happy if something is sold for more than retail price mentioned on the product itself. Therefore, wholesalers offer trade discount to the retailer which reduces the cost of purchase to the retailer and afterwards retailer extracts the profits from end customers on the difference.