Discounts are commonly used for business promotions. They are often used to sweeten the deal between a buyer and a seller. Discounts reduce the asking price of a particular product or service.
Meaning of trade discount and purpose
Manufacturers often prepare product catalogues for wholesalers, retailers and other resellers. These product catalogues will contain the listed prices of the products. However, when a reseller offers to buy the product in bulk, the manufacturer reduces the listed price of the product. This is called a trade discount.
Trade discounts are often given based on good manufacturer-buyer relationships or in the event of bulk orders.
Calculation of trade discount with examples
Wholesalers tend to get better trade discounts since they buy products in bulk.
For instance, CS Ltd wishes to buy 200 guitars from GB Ltd. The list price of the guitars stands at Rs.2,000 per piece. GB Ltd offers a trade discount of 25% considering the size of the deal. The trade discount amounts to Rs. 500 per guitar (Rs.2,000 * 25%).
CS Ltd now gets the guitars at Rs.1,500 per piece on purchase.
GST laws on the treatment of trade discount
The GST laws state that there will be no difference in trade discounts and cash discounts. Where a discount is mentioned on the invoice’s face, the discount may be reduced from the taxable value of the supply of goods.
In the event the discount is not mentioned on the face of the invoice, the discount may still be reduced if-
- The supplier and the buyer have entered into an agreement that includes a provision about the discount factor.
- The discount is linked to a specific invoice.
- Any input tax credit attributable to the discount must be reversed by the buyer or recipient of the supply.
Accounting of trade discount
Trade discounts are usually based on the list price (catalogue price). Sales are recorded based on net price. Net price = List price – Trade discount. Therefore, trade discounts are not recorded in the books of accounts.
However, on the other hand, cash discounts are recorded in the books of accounts. Cash discounts are usually allowed on the invoice price of the goods.
Example: PVS Ltd places an order for 15 shirts with DVS Ltd. The list price of the shirts is Rs.500 each. The trade discount applicable is 10%. DVS Ltd allows them a further discount of Rs.1,000 if the payment is made immediately. PVS Ltd chooses to make an immediate payment.
List price (15*500) 7,500
(-)Trade discount @ 10% (750)
Net price6,750
In the books of PVS Ltd, the following entry is made:
Purchases A/c ……….. Dr 6,750
To Discount Received A/c 1,000
To Cash A/c 5,750
(Being goods purchased from DVS Ltd worth Rs.7,500 upon which
there was a 10% trade discount and cash discount of Rs.1,000)
Trade discount in invoice
Comparison between trade discount and cash discount
| Trade Discount | Cash Discount |
|---|---|
| Reduction is given in the list price (catalogue price) of the goods by the manufacturer to the wholesaler | Allowance is given to the customer by the seller on the invoice price of the goods if the payment is made immediately |
| Given as a result of common trade practices, especially where bulk deals take place | Given as an incentive for early or immediate payment |
| Usually a fixed percentage | Percentage may or may not be fixed |
| Based on the quantity factor (size of the purchase) | Based on the time factor (period of payment) |
| Transaction may be on credit or a cash basis | Only on a cash basis |
| Reduction is made on listed price (catalogue price) | Reduction is made on the invoice price |
| Given to promote sales | Given to recover payments quickly |
ClearOne provides several validations to ensure that you report discounts accurately in the invoices.
