Most businesses operate in a competitive environment today. This necessitates that they offer their products and services at competitive prices, to be able to sustain good sales volume. This is why vendors are often seen offering discounts to their customers. Any reduction in price offered by vendors to their customers is termed as ‘discount’. Discounts are offered at different stages in the distribution cycle of a product – from manufacturer/trader to wholesaler to distributor to retailer to the ultimate consumer.
This article looks at meaning of and differences between two types of discount –trade discount and cash discount.
Definitions and explanations
Trade discount:
A trade discount is the price reduction offered on the list price of the products, at the wholesale stage of the distribution cycle of a product. This may be offered by a manufacturer/trader or a wholesaler or a distributor.
Trade discounts are offered on bulk purchases by traders, wholesalers, distributors or retailers and not to the end consumers. Manufacturers or traders generally have a list/catalog price which is recommended as final sale price to the end consumer, a trade discount is offered to resellers on this list price. This allows resellers to earn profits on their retail sales to consumers by purchasing at a price below list price and selling at list price to the end consumers.
Trade discounts are generally offered at varied rates depending on the volume of sale i.e., generally, the larger the purchase volume by the buyer, the higher the discount % offered by the seller.
Neither the seller offering the trade discount (manufacturer, wholesaler or trader) nor the buyer receiving the discount, neither records the same in its books of accounts. This means that it records the sales at the price net of discount.
For example, M/s XYZ has sold 100 cartons of juice to its distributor. Each carton is priced at $50, and a trade discount of 20% is offered for sales exceeding 50 cartons.
- Total sales value (at gross price): 100 × 50= $5,000
- Trade discount @ 20%: $1,000 (= $5,000 × 20%)
- Net sales value = 5000-1000= $4,000
This net sales value/purchase value, after considering impact of trade discount is recorded in the books of accounts of M/s XYZ and distributor would be as follows:
Books of M/s XYZ:
Accounts receivable 4000 [Dr.]
Sales 4000 [Cr.]
Books of distributor:
Purchases 4000 [Dr.]
Accounts payable a/c 4000 [Cr.]
Cash discount:
A cash discount is the price reduction offered on the invoice price of the products, to encourage early payment for the products. This can be offered by a manufacturer, trader, wholesaler, distributor or even a retailer.
Sellers often allow credit period to buyers to pay for their purchases. Sellers offer cash discounts to their buyers as an incentive to encourage early payment i.e., payment of dues by the buyers in a time frame shorter than the credit period. This helps sellers realize their sales dues earlier as well as saves them from the administrative hassle of following up for settling dues.
For example, a wholesaler offering a credit period of 30 days to the retailer, may offer a cash discount of say 2% in case the retailer pays the invoice earlier, say within 10 days.
Cash discount is recorded in the books of accounts by both the seller and the buyer. The seller accounts for this as sales discount and the buyer accounts for it as purchase discount.
Continuing the above example, say M/s XYZ offers a cash discount of 2% to the distributor for immediate payment of dues. The additional entry made by M/s XYZ and the distributor in their books of accounts would be as follows:
Books of M/s XYZ:
Bank 3200 [Dr.]
Sales discount 800 [Dr.]
Accounts receivable 4000 [Cr.]
Books of distributor:
Accounts payable 4000 [Dr]
Bank 3200 [Cr.]
Purchase discount 800 [Cr.]
Sellers usually adopt one of two methods to deal with the recording of cash discount in their books of accounts. These are known as gross method of cash discount and net method of cash discount.
Difference between trade discount and cash discount:
The difference between trade discount and cash discount has been detailed below:
1. Meaning
- A trade discount is a discount offered on the list prices of products on wholesale purchases.
- A cash discount also termed as ‘early payment discount’ is the discount offered on the billed price of products to incentivize early clearance of dues.
2. Purpose
- Higher trade discounts are generally offered on higher sales volume, increasing the scope for higher profit margins when the resellers ultimately sell the products to the end buyer. The purpose of trade discount is to thus encourage bulk purchases by resellers.
- The purpose of offering cash discount is to encourage early payment of sales price by the buyer.
3. Offered on
- Trade discount is offered on bulk or whole sale product purchases, at their list prices.
- Cash discount can be offered on all purchases, at their invoice prices.
4. Offered by
- Trade discount is offered by sellers who sell in bulk – mainly manufacturers, traders, wholesalers or distributors. Retailers who sell to end consumers do not offer trade discount.
- Cash discount can be offered by any sellers who wishes to encourage early payment, including retailers.
5. Received by
- Trade discount is received by buyers who purchase in bulk – this can include traders, wholesalers, distributors or retailers.
- Cash discount can be received by all buyers who agree to make early payments for their purchases.
6. Timing
- Trade discount is offered at the time of purchase itself.
- Cash discount is offered at the time of payment.
7. Accounting impact
- Trade discount is not recorded in the books of accounts, either by the sellers or buyers i.e., sales are accounted for at value net of trade discount.
- Cash discount is recorded in the books of accounts as sales discount by sellers and purchase discount by buyers.
8. Dependent on
- Trade discount varies with and is dependent on volume of purchases.
- Cash discount, on the other hand varies depending on how early the payment for purchases is made.
9. Quantum
- Trade discounts are generally offered at higher percentages (5,10,20% etc).
- Cash discounts are typically offered at lower percentages – 1 to 2%.
Trade discount vs cash discount – tabular comparison
A tabular comparison of trade discount and cash discount is given below:
|
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| Meaning | ||||
| A discount on list price mostly offered to whole sale customers who purchase goods in bulk | An early payment discount offered on billed/invoice price | |||
| Purpose | ||||
| To encourage bulk purchases | To encourage prompt/early payments | |||
| Offered on | ||||
| list price of goods sold | Invoice price of goods sold | |||
| Offered by | ||||
| Producers/manufacturers and whole sellers who wish to sell in large or bulk quantities to boost their profit | Any seller who wishes to convert his/her accounts receivables into cash quickly or before due date | |||
| Received by | ||||
| Mostly resellers who are in a position to make purchases in large quantities and avail a trade discount | Any buyer who is in a position to make early payment and avail a cash discount | |||
| Timing | ||||
| Available at the time of purchase or sale | Available at the time of payment or collection of cash | |||
| Accounting impact | ||||
| Not recorded in formal books of accounts | Recorded in formal accounting records by both seller and buyer | |||
| Dependent on | ||||
| Depends on quantity purchased | Depends on how early cash is paid for goods bought | |||
| Quantum | ||||
| Percentage of discount offered is usually higher. Normally between 5 to 20 percent | Percentage of discount offered is usually lower. Normally between 1 to 2 percent. | |||
Conclusion – trade discount vs cash discount:
Both trade discount and cash discount are frequently used by most sellers during the course of their business operations. Sellers generally use a combination of both these forms of discount to increase their sales, retain customers as well as to manage the aging of their debtors.
