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In layman’s language, a trade discount refers to a reduction/fall in the original price of a commodity being sold. This type of discount is usually granted on the list price of the products by the supplier or wholesaler to the retailer for considerations such as buying goods in bulk, trade relations, etc.
No journal entry is recorded separately in the books of accounts for trade discounts. The entries that are shown in the sales or purchase books are recorded as the net amount.
This type of discount is simply utilized to determine the net amount for a customer. Since the trade discount is deducted before any exchange takes place, it does not have any accounting entry.
Example
Mr.A sells goods to Mr U amounting to the list price of 8,000 and offers a trade discount of 10% as the customer purchased goods in bulk. Pass the necessary journal entries for this transaction.
Solution:
The net price will be calculated as follows:
List price = 8,000
Trade discount = 10%
Net amount = 8,000 – (8,000 x 10%)
= 8,000 – 800
= 7,200
The journal entry in the books of the seller (Mr. A) is as follows;
| Cash a/c | Debit | 7,200 |
| To Sales a/c | Credit | 7,200 |
(Being goods sold)
While recording in the journal entry, the discount amount will be deducted from the total amount, hence the net amount will be recorded.
Rules as per the Modern Approach
| Account | Nature of Account | Rule |
| Cash A/c | Asset | Debit the increase in asset |
| Sales A/c | Revenue | Credit the increase in Revenue |
As cash is coming into the company due to sales, it leads to an increase in assets hence it is debited. This is leading to an increase in revenue hence it is credited.
Rules as per the Traditional Approach
| Account | Nature of Account | Rule |
| Cash A/c | Real | Debit what comes in |
| Sales A/c | Nominal | Credit all incomes and gains |
As the cash is coming into the company due to sales, it is debited. The sales are credited since it is the reason leading to an increase in income hence they are credited as per the nominal account rule.
The journal entry in the books of Mr. U is as follows:
| Purchase a/c | Debit | 7,200 |
| To Cash a/c | Credit | 7,200 |
As the goods are being purchased with a discount of 10%, it is debited and as the cash is going out it is credited. The discount amount of 800 is subtracted from the total 8,000 the net amount of 7,200 is recorded as it is being bought in bulk and a trade discount is being provided. (Being goods purchased)
Rules as per the Modern Approach
| Account | Nature of Account | Rule |
| Purchase A/c | Expense | Debit the increase in expense |
| Cash A/c | Asset | Credit the decrease in asset |
The purchases account is debited since there is an increase in expenses. The cash account is credited since there is a decrease in assets as payment is made for the purchases.
Rules as per the Traditional Approach
| Account | Nature of Account | Rule |
| Purchase A/c | Nominal | Debit all expenses and losses |
| Cash A/c | Real | Credit what goes out |
The purchases account is debited since its an expense for the company. As the cash is going out from the company for the payment it is credited as per real account rule.
Note:
- The seller and the buyer will record the transactions in the books of accounts after subtracting the trade discount allowed from the original amount.
- As shown in the example above, the distributor and Mr. U shall record the transaction at 7,200.
- No separate entry shall be shown for a trade discount.
Conclusion
The key takeaways from the above article are as follows:
- A trade discount is a reduction/fall in the original price of a commodity being sold.
- It is usually granted on the list price of the products by the supplier to the buyer for reasons such as buying goods in bulk, trade relations, etc.
- No journal entry is recorded separately in the books of accounts for trade discounts.