Trade Discount and Cash Discount
In this lesson, you will learn the differences between trade discounts and cash discounts, how to calculate each, and the correct accounting treatment for both. You will also understand the difference between discount allowed and discount received, and how to record them in the journals and ledger accounts.
Related Lessons:
Trade Discount
Trade discounts are given by businesses to encourage their customers to buy in bulk. A business can give trade discounts to its customers and receive it from their suppliers.
To calculate trade discounts, we multiply the percentage of trade discount to the original selling price which is also known as the list price.
Example: trade discount of 10%
Original selling price $1,000
Trade discount: 1,000 x 10% = $100
Net selling price is the price after deduction of trade discount. To calculate, we minus the amount of trade discount from the 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. A business can give cash discount to its trade receivables or receive one from its trade payables.
Discount received
When a business pays its credit suppliers on time and receives cash discount, it pays less than what it owes to the trade payable by the discount received. Therefore, discount received is considered an income to the business.
To calculate the 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
To account for discount received:
Dr Trade payable $900
Cr Cash or Bank $855
Cr Discount received $45
At the end of the month, the amount in the discount received account is transferred to the Income Statement.
Discount allowed
When a credit customer pays its debt on time and the business gave a cash discount, the business receives less than what is owed to it by the discount given. Therefore, discount allowed is considered 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
To account for discount allowed:
Dr Cash or Bank $760
Dr Discount allowed $40
Cr Trade receivable $800
At the end of the month, the amount in the discount allowed account is transferred to the Income Statement.
Difference Between Trade and Cash Discount
A trade discount is calculated based on the original selling price of the goods and reduces the listed price.
In contrast, a cash discount is calculated based on the net selling price. It reduces the actual amount payable by customers or the amount to be paid to suppliers.