Everything you need to know about trade discounts [explained by a Certified Accountant]

Explanation: When Is Trade Discount Given?

Trade discount, also known as functional discount, is a reduction in catalogue price granted by manufacturers and wholesalers to their resellers based on order volume and status, as a custom of the trade, or to reward other members of their distribution channels for performing different functions.

Trade discount, or functional discount, is a list price allowance given by manufacturers or wholesale distributors to:

1.  Encourage frequent purchases in bulk from resellers like retailers or other wholesalers

2.  Reward functions of members in the same distribution channel or supply chain

3.  Comply with trade customs

As an example, let’s suppose that:

  • 1. A manufacturer’s original catalogue list price of a product is $100.
  • 2. When the manufacturer sells to a large well-known retailer, the catalogue list price is decreased by a trade discount of 5% or $5.
  • 3. The retailer then charges a full retail price of $105 to its customers.
  • 4. The retailer earns a profit ($10 = $105 - $95) on the difference between the discounted list price paid to the manufacturer ($100 - $5 = $95) and the final retail price at which it re-sells the product to the end-consumers ($105).

Formula: How Is Trade Discount Calculated?

A trade discount, or a functional discount, is deducted from a seller’s original catalogue list price either as a specific monetary amount or a percentage reduction, in which case the trade discount amount is calculated by multiplying the list price by the discount percentage.
Calculation Formula: Trade Discount
Trade Discount Format Trade Discount Calculation Price After Trade Discount
Percentage Trade Discount Amount = List Price x Trade Discount Percentage Net Amount Payable = List Price x (1 - Trade Discount Percentage)
Amount No calculation required as a seller provides the discount amount. Net Amount Payable = List Price – Trade Discount Amount

3 Examples: Step-by-Step Trade Discount Calculation

Question:

Company A is a manufacturer who does not sell to end-consumers but only to wholesalers, distributors, retailers and other resellers.

Although Company A has a catalog that lists the official price for each product, it allows trade discounts from the catalog list price based on each buyer’s order volume as follows:

Price List of Company A
Order Quantity Product #1 Product #2 Product #3
1-100 units $10 $20 $30
101-999 units $9 $18 $27
1000-4999 units $7 $16 $21
>5000 units $5 $10 $15

In addition to the discount based on order volume, Company A offers further:

  • 5% trade discount to long-term customers with good credit standing
  • 5% functional discount to members of its parent company’s supply chain

This week, Company A made the following sales:

Sales Order List of Company A
Customer Product Quantity Additional trade discounts
Reseller A Product #1 10,000 Additional 5% trade discount granted as Reseller A is one of Company A’s best customers.
Reseller B Product #2 1,000 Additional 10% functional discount granted as Reseller B is a trustworthy long-term business partner (5%) and a member of Company A’s supply chain (5%).
Reseller C Product #3 500 No additional trade discount granted as Reseller C is a new buyer with whom Company A has never done business before.

Solution: Step-by-Step Calculation

Reseller A

Reseller A was given a trade discount of $52,000 from the catalog list price and so was invoiced only for $47,500. >>>

Trade Discount Calculation: Example [Reseller A]
Product units purchased 10,000
List price per unit $10
Total purchase list price $100,000 (10,000 x $10)
Price per unit after trade discount $5
Trade discount $50,000 (10,000 x ($10 - $5))
Purchase price after trade discount $50,000 (10,000 x $5)
Additional trade discount - percentage 5%
Additional trade discount - amount $2,500 ($50,000 x 5%)
Total trade discount $52,500 ($50,000 + $2,500)
Total final purchase price after all trade discounts $47,500 ($100,000 - $50,000 - $2,500)

Reseller B

Reseller B will pay $14,400 for its order because it was granted a $5,600 functional discount. >>>

Trade Discount Calculation: Example [Reseller B]
Product units purchased 1,000
List price per unit $20
Total purchase list price $20,000 (1,000 x $20)
Price per unit after trade discount $16
Trade discount $4,000 (1,000 x ($20 - $16))
Purchase price after trade discount $16,000 (1,000 x $16)
Additional trade discount - percentage 10% (2 x 5%)
Additional trade discount - amount $1,600 ($16,000 x 10%)
Total trade discount $5,600 ($4,000 + $1,600)
Total final purchase price after all trade discounts $14,400 ($20,000 - $4,000 - $1,600)

Reseller C

Reseller C received a trade discount of $1,500, which results in the final order price of $13,500. >>>

Trade Discount Calculation: Example [Reseller C]
Product units purchased 500
List price per unit $30
Total purchase list price $15,000 (500 x $30)
Price per unit after trade discount $27
Trade discount $1,500 (500 x ($30 - $27))
Purchase price after trade discount $13,500 (500 x $27)
Additional trade discount - percentage 0%
Additional trade discount - amount $0
Total trade discount $1,500
Total final purchase price after all trade discounts $13,500

Recognition: How are Trade Discounts Recognized?

A trade discount is not separately recognized in accounting general ledger because it is used to calculate the net price of goods or services before an exchange transaction takes place that a buyer and seller will later record as a respective purchase or sale at an amount net of the trade discount.

Where are trade discounts shown?

Trade discounts are not shown in a separate general ledger account because an accounting journal entry is made only after deducting the trade discount from the original list price of goods or services sold and purchased.

Even though trade discounts can be recorded in the daily purchase and sales books for bookkeeping needs, there is no separate journal entry made into the general ledger for accounting purposes.

Journal Entry: How to Record Trade Discounts?

There is no journal entry made in the accounting books of a buyer and seller for the trade discount amount because they record the respective sale and purchase at a price net of the trade discount (= Gross List Price Amount – Trade Discount).

Since a trade discount is deducted before any exchange takes place, it is not part of an accounting transaction that would give rise to a journal entry into the accounting records of an entity.

Trade Discount - Journal Entry
Entity Debit Credit
Seller Accounts Receivable (asset) Sales (revenue)
Buyer Purchases (expense) Accounts Payable (liability)

For example, let’s say that Manufacturer M sells 1,000 units of product on credit to a Wholesaler W at a list price of $10 per unit, with a 5% trade discount granted by the seller to the buyer.

  • Total list price = 1,000 units x $10 per unit = $10,000
  • Trade discount = $10,000 total list price x 5% trade discount = $500
  • Net amount after trade discount to be recorded = $10,000 list price – $500 trade discount = $9,500

The only journal entry made is for the final net price ($9,500) at which the exchange takes place. The list price ($10,000) and the trade discount ($500) are not separately entered into the accounting records.

The double-entry for the post-discount net amount of $9,500 is as follows:

Example: Trade Discount - Journal Entry
Entity Amount Debit Credit
Seller (Manufacturer M) $9,500 Accounts Receivable (Wholesaler W) Sales Revenue
Buyer (Wholesaler W) $9,500 Purchase Expenses Accounts Payable (Manufacturer M)

Benefits: Why Is Trade Discount Given?

The 10 most common scenarios in which it is beneficial to for a seller to offer a trade discount and for a buyer to accept it:

5 Reasons for a Seller to Give a Trade Discount:

  1. Grow market share

  2. Increase short-term sales

  3. Clear out excess or expiring inventory

  4. Reward valuable customers (e.g., frequent and large purchases)

  5. Compensate supply chain members (e.g., storage, sales, credit, records)

5 Reasons for a Buyer to Take a Trade Discount:

  1. Lower costs

  2. Boost purchasing power

  3. Improve price competitiveness

  4. Increase sales to end-consumers

  5. Build up goodwill (e.g., higher discounts and credit facilities in the future)

What's the Difference Between Trade and Functional Discounts?

A trade discount is also known as a functional discount and the two terms are used interchangeably. Nevertheless, a functional discount sometimes refers specifically to a reduction in list price granted to members of a seller’s distribution channel to reward them for their function in the supply chain.

What’s the Difference Between Trade and Cash Discounts?

Trade discount is a deduction offered by a seller on a listed price at the time of sale to encourage bulk orders on credit or in cash that is not recognized in accounts, while cash discount is based on an invoice price as an incentive for a prompt cash payment that is recorded in accounting books.

Calculation: Trade vs. Cash Discount

Even though a trade discount and a cash discount are both sales discounts, they are calculated at a different stage of the sale process:

Calculation Formula: Trade & Cash Discount
Discount Type Calculation Formula
Trade Discount List Price
(Trade Discount)
Cash Discount = Invoice Price
(Cash Discount)
Final Amount Due = Net Invoice Amount Paid

6 Differences: Trade vs. Cash Discount

There are 6 important distinctions between a trade discount and a cash discount that you need to know:

Top 6 Differences Between Trade Discount and Cash Discount
Difference Trade Discount Cash Discount
1. Timing At the time of purchase At the time of payment
2. Basis List price Invoice price
3. Seller’s Motivation Increase sales and market competitiveness Accelerate cash inflows by encouraging buyers to pay invoices early
4. Amount Changes based on the frequency and size of a buyer’s purchases Changes based on how promptly a buyer settles an invoice
5. Accounting Recognition Not separately recognized as not a part of an exchange transaction Entered into accounting records and shown separately from a sale/purchase
6. Payment Method Cash and credit Cash only

Journal Entry [Example]: Trade vs. Cash Discount

In order to illustrate the difference between how trade and cash discounts are recorded in the books of accounts, let’s say that a Manufacturer M sells $10,000 worth of product to Wholesaler W at a 10% discount, of which:

  • 5% is a trade discount that rewards a bulk payment
  • 5% is a cash discount that rewards an early invoice payment within 30 days

The general ledger double-entry postings from the buyer’s point of view:

Trade vs. Cash Discount: Accounting Journal Entry - Example
Buyer’s Books (Wholesaler W)
Transaction Account Debit Credit
Invoice received (trade discount included) Purchase Expenses $9,500
Accounts Payable (Manufacturer M) $9,500
Invoice paid within 30 days (cash discount included) Accounts Payable (Manufacturer M) $9,500
Discounts Received $475
Bank $9,025

The general ledger double-entry postings from the seller’s point of view:

Trade vs. Cash Discount: Accounting Journal Entry - Example
Seller’s Books (Manufacturer M)
Transaction Account Debit Credit
Invoice issued (trade discount included) Accounts Receivable (Wholesaler W) $9,500
Sales Revenue $9,500
Invoice payment received within 30 days (cash discount included) Accounts Receivable (Wholesaler W) $9,500
Discounts Granted $475
Bank $9,025

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