A trade discount is a discount given to customers ordering in large quantities or as an incentive for to encourage regular customers to place more orders. Trade discounts are simply a reduction in the selling price of goods at the point of sale.
Trade discounts are given to customers for a variety of reasons. The main reason a trade discount is offered is to encourage customers to either purchase more goods over a period of time and/or to encourage customers to place larger individual orders.
For example, trade discount may be offered to customers as a reward for loyalty over a period of time. Alternatively, trade discount could be offered on any individual order to purchase, say, 100 units or more in a single transaction.
It is normal policy to show the percentage of trade discount on the face of a sales invoice. For example if the list price of goods is $100 and a 10% trade discount given then this is shown on the invoice as:
The customer pays the net price. If sales tax is charged, it should be added to the net price, and the customer is required to pay the net price plus sales tax. Different percentages of trade discount may be applied to different products, in which case the relevant percentage discount is normally shown against each product on the invoice before sales tax is calculated, as in the following presentation:
| Product | Description | Quantity | Item price | Discount | Total |
|---|---|---|---|---|---|
| HS336 | Table | 1 | $100.00 | 10% | $90.00 |
| HS472 | Chair | 6 | $90.00 | 5% | $513.00 |
| Total | $603.00 | ||||
| Sales tax @ 20% | $120.60 | ||||
| 723.60 | |||||
Once again, trade discount is excluded from the general ledger of both the customer and the seller and both parties will account for this transaction at the value of $723.60,
Therefore, the transaction is recorded by the seller at the trade-discounted price and will be accounted for by the customer using the same monetary value. Therefore, trade discounts are not included in the accounting records of either the seller or the customer.
A settlement discount ('early settlement discount' or 'prompt payment discount') is a discount offered by the seller to the buyer for early payment of a debt i.e, within a specified period of time before the normal due date. Typically , an invoice from a seller will state that payment is due 30 days from the invoice date. However, to persuade the customer to settle early, a percentage discount will be offered if payment is made before the due date. This discount is known as a settlement discount.
A settlement discount is therefore different in nature to a trade discount. A trade discount is a definite reduction in price that is given by the seller to the buyer. A settlement discount is a reduction in the overall invoice price that is offered to the customer. It is for the customer to decide whether to accept the early settlement terms offered and pay the reduced amount within the required timescale, or to pay the full invoice amount at a later date.
A typical wording of a settlement discount may be '4% cash discount for payment within 14 days otherwise net 30 days. This may be abbreviated to: '4/14, net 30'.This means that if the customer decides to pay the invoice within 14 days of the invoice date then the customer can deduct 4% from the invoice total and only pay the reduced amount. However, if the customer decides not to accept the settlement discount the full amount should still be paid within 30 calendar days.
In practical terms if a seller offers settlement discount to a credit customer, there is no way of knowing, at the point when the invoice is prepared by the seller, whether the customer will take advantage of the settlement discount terms offered and pay the reduced amount. This is known as ' variable consideration' as the seller does not know at the time the sale is recorded is recorded whether it will receive only the reduced (discounted) amount or the full amount.
A seller could therefore adopt one of the following approaches to deal with this situation:
For example, a question may include be wording such as...a business sold goods to a customer on credit. At the point of sale, the customer was (or was not) expected to take advantage of the early settlement discount terms offered...... If the customer is not expected to take advantage of the early settlement discount terms, the invoice prepared by the seller would consist of the following amounts:
The accounting entries recorded by the seller in the general ledger would be as follows:
If, as expected, the customer does not take advantage of the settlement discount available, the full amount of $200.00 should be paid by the customer. When the cash is received, the accounting entries to record this would be as follows:
If however, the customer does take advantage of the settlement discount terms, they will pay $194.00. The total receivable of $200.00 must be cleared, even though only $194.00 has been received. This would be accounted for by making an adjustment to revenue as follows:
If the customer is expected to take advantage of the early settlement discount terms, the invoice prepared by the seller would consist of the following amounts:
In this situation, settlement discount allowed is excluded from the accounting records in the same way as trade discount is excluded from the accounting records. The accounting entries initially recorded by the seller would be as follows:
Subsequently if, as expected, the customer pays within ten days to take advantage of the early settlement terms, the receipt of cash will be accounted for as follows:
If the customer does not take advantage of the early settlement terms, the full amount of $200.00 is due. When it is received, the additional receipt of $6 is accounted for as if it were an additional cash sale as follows:
Goods were sold to a credit customer at a list price of $1,250, subject to a trade discount of 20%. The customer has also been offered 2.5% discount for early settlement of the invoice. Show the relevant entries in the receivables and revenue general ledger accounts to record the initial transaction, and then record the subsequent receipt of cash in the receivables and the cash at bank account if the customer is not expected to take advantage of the settlement discount terrns offered and subsequently pays outside of the discount period.
For a suggested answer, see the Answers' section at the end of the book
Goods were sold to a credit customer at a list price of $1,250, subject to a trade discount of 20%. The customer has also been offered 2.5% discount for early settlement of the invoice. Show the relevant entries in the receivables and revenue general ledger accounts to record the initial transaction, and then record the subsequent receipt of cash in the receivables and the cash at bank account if the customer is expected to take advantage of the settlement discount terms offered, and subsequently pays within the discount period.
For a suggested answer, see the 'Answers' section at the end of the book.
Goods were sold to a credit customer at a list price of $1,250, subject to a trade discount of 20%. The customer has also been offered 2.5% discount for early settlernent of the invoice. Show the relevant entries in the receivables and revenue general ledger accounts to record the initial transaction, and then record the subsequent receipt of cash in the receivables and the cash at bank account if the customer is expected to take advantage of the settlement discount terms offered, and subsequently pays after the discount period has expired.
For a suggested answer, see the 'Answers' section at the end of the book
Goods were sold to a credit customer at a list price of $1,250, subject to a trade discount of 20%. The customer has also been offered 2.5% discount for early settlement of the invoice. Show the relevant entries in the receivables and revenue general ledger accounts to record the initial transaction, and then record the subsequent receipt of cash in the receivables and the cash at bank account if the customer is not expected to take advantage of the settlement discount terms offered but who subsequently pays promptly within the early settlement period.
For a suggested answer, see the 'Answers' section at the end of the book.
Discounts received arises when a settlement discount is taken by a business paying a supplier. The business will pay a reduced amount to the supplier in full settlement of the amount due. The remainder of the debt is then transferred to the statement of profit or loss as a discount received (credit entry) increasing profit. This does need to be accounted for as the business will decide for itself whether to take advantage of the discount terms offered by the supplier. When making the payment to the seller, the accounting entries will be as follows:
A purchase invoice with a value of $500 offering a 2% discount for early settlement is paid before the normal payment date by the business. Show the relevant entries in the payables and discounts received general ledger accounts of the customer.
For a suggested answer, see the 'Answers' section at the end of the book.