Trade Discount and Cash Discount
In this lesson, we will learn the differences between cash discounts and trade discounts, how to calculate each type, and the appropriate accounting treatment for both. We will also distinguish between discount allowed and discount received and learn how to record them in the journal and ledger accounts.
Related Lessons:
Trade Discount
Trade discounts are given by businesses to encourage their customers to buy in bulk.
To calculate trade discounts, we multiply the percentage of trade discount to the original selling price.
Example: trade discount of 10%
Original selling price $1,000
Trade discount: 1,000 x 10% = $100
To calculate net selling price, that is price after trade discount, we minus trade discount from original selling price.
Continuing from the above example,
Net selling price = 1,000 – 100 = $900
There is no double entry to record trade discount. Instead, only the net selling price is recorded as sales revenue.
Cash Discount
Cash discounts are given by businesses to encourage their credit customers to pay on time.
Cash discounts are recorded as discount received or discount allowed.
Discount received
Are cash discount received by businesses from their credit suppliers on prompt payment. Therefore, it is an income to the business.
To calculate discount received, we multiply the percentage of cash discount to the amount owing to a trade payable.
Example: cash discount of 5%
Amount owing $900
Discount received: 900 x 5% = $45
To calculate the amount paid, we minus discount received from the amount owed.
Continuing from the above example,
Amount paid = 900 – 45 = $855
Accounting for discount received:
Dr Trade payable…………………….$900
Cr Discount received………$45
Cr Cash at bank……………..$855
Discount allowed
Are cash discount given by businesses to their credit customers on prompt payment. Therefore, it is an expense to the business.
To calculate discount allowed, we multiply the percentage of cash discount to the amount owed by a trade receivable.
Example: cash discount of 5%
Amount owed $800
Discount allowed: 800 x 5% = $40
To calculate the amount received, we minus discount allowed from the amount owed.
Continuing from the above example,
Amount received = 800 – 40 = $760
Accounting for discount allowed:
Dr Cash at bank……………$760
Dr Discount allowed…….$40
Cr Trade receivable……………$800
Difference Between Trade and Cash Discount
Trade discount is calculated based on the original selling price of the goods. As such, trade discount reduces the selling price of goods.
On the other hand, cash discounts are calculated based on the net selling price of the goods. Applying cash discount reduces the amount to be paid by customers or to suppliers.