What is a trade discount and how to record it?

A trade discount is a reduction of the list price of products from a seller to a buyer as an incentive for future business. The trade discount is given as a percentage to deduct from the list price which is the normal selling price. In order for a buyer to receive a trade discount from a seller, there are a few conditions that must be met.

Conditions of a trade discount

It is given to businesses not individuals

Only businesses can receive a trade discount, not individuals. This is because businesses are involved in daily transactions and need to purchase goods regularly.

This is beneficial to a seller because business is ongoing with the buyer. Individuals however usually make one-time purchases to satisfy an immediate need which is of no benefit to a seller.

Businesses must be engaged in the same line of activity

A trade discount is offered to a buyer who is engaged in the same line of activity as the seller. Since the trade discount is an incentive to encourage the buyer to come back, then a buyer in the same line of business ensures that business will continue.

A business that is not in the same line of business however might be making a one-time purchase from the seller to fulfil a particular need at that point. This buyer may not return to do any further business and is of no benefit to the seller.

Order must be large

A bulk purchase is another condition for a business to receive a trade discount. Volume discount is an economic incentive given to businesses to encourage them to buy in large quantities.

The more goods are sold at a cheaper price, the faster stock can reach the consumers. Since retailers purchased the goods at a discounted price, they too may pass on the reduced price to the consumers at stores.

How to record a trade discount

Recording a trade discount is very simple. When you are given a list price of a product and a trade discount percentage, calculate the deduction first. Only record the net amount due in the journal.

Example:

On June 1, ABC Ltd purchased goods at list price $2,000 less 25% trade discount.

Calculate 25% of $2,000 = $500

Deduct $500 from $2,000 = $1,500

Record amount due in journal as $1,500

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