When shopping for items in a physical store or online, most people are very zealous for a discount. Getting a discount makes many people happy and entices them to buy again from the same seller. For this reason, many sellers offer discounts to their customers in order to increase their sales. It is an inducement for the customer to buy again from the buyer.
Depending on the reason for granting discounts, there are two types of discounts: the cash discount and the trade discount. These terms can confuse many people and, therefore, the purpose of this article is to distinguish them with the aim of making them easier to understand.
What Is A Trade Discount?
Trade discount is given by the seller to the buyer on the list price of the goods purchased. The reason for this discount is to increase sales by encouraging the buyer to purchase more and in larger quantities. It could be a manufacturer to a wholesaler or a wholesaler to a retailer or any other relationship having one as a buyer and the other as a seller. It is aimed at retaining the buyer for longer by encouraging them to redo their purchases from the buyer. This discount is usually deducted from the invoice and therefore is not shown on the cashbook.
What Is A Cash Discount?
Credit is an important part of every business. All major business concerns are based on credit transactions. It is the expectation of the business and the will of the seller that when goods are sold on credit, the money will be repaid quickly and in full. As a result of this, the seller may give a discount to the debtor for repayment of the money at an earlier date. This type of discount is called a cash discount. The objective of cash discount is to stimulate debtors who bought goods on credit to repay earlier.
Cash Discount In Accounting
There are two types of cash discount: discount allowed and discount received. We will learn how they are recorded in the cashbook and income statement.
Cash Discount In The Cash Book
In accounting, discount is shown on the discount column on the debit side of a seller's cashbook, which is called discount allowed. However, if you are the payer receiving the credit plan prepayment discount, it will appear on the credit side of the cashbook (discount received) but still in the discount column.
Cash Discount In income statement
In the income statement, discount received is an income and it is added to the gross profit alongside other income. Discount allowed is shown on the expenses side of the income statement. It is added to other expenses and deducted from the gross profit to arrive at the net profit.
Similarities Between Trade Discount And Cash Discount
Although in accounting, trade and cash discounts have different concepts, however, they share some similarities due to the fact that they have a primary end goal in the best interest of a business. Some of the similarities between cash and trade discount are briefly discussed below.
While all other characteristics such as the basis of issuance of a discount and the entry (or lack thereof) in the books may be different, both are discounts, as the name suggests. This implies that resulting from a reduction in cost, the buyer would have incurred in the interest of the company a certain advantage which depends on the type of discounts offered by the company.
Generally, a discount is defined as an allowance granted to the customer for a particular situations. It is given by the seller to the buyer and is therefore not real money. Rather, it is a reduction from the amount of cash the seller has to pay the buyer for the goods purchased if they meet certain standards depending on the type.
2. Parties Involved
The trade and cash discount relate to the same number of participants. They each have two parties involved: the buyer and the seller. This type of relationship can exist between manufacturers such as sellers or creditors and wholesalers as buyers or debtors, wholesalers as sellers or creditors and retailers as buyers or debtors etc. Transactions are usually between two parties where the buyer or the debtor (depending on whether the discount is a trade discount or a cash discount, respectively) receives a discount from the seller or the creditor.
Taking into consideration the objective of discount, it can be argued that each of the discounts has a particular and distinct goal that they want to achieve, but in the end, both discounts have the same long-term goal, for the benefit of the business. The purpose of the trade discount is to retain the customer(s) and encourage the customer to make more purchases therefore increasing sales which are a gain for the company.
Cash discount, on the other hand, also benefits the business by allowing debtors who make purchases via credit incentives to pay up their accounts at an early date and thus prevent the risk of financial problems such as bankruptcy and even collapse of the company in extreme situations.
What Is Difference Between Cash And Trade Discount?
The basic distinction between cash discount and trade discount is that while trade discount is reduction on list price and it is granted to the customer on the basis of bulk purchases, cash discount is given to customers on the basis of prompt payments of accounts especially when the transaction was done on credit.
This will be your guide if you are asked in your examination to write any three differences between trade discount and cash discount. The differences between cash and trade discounts are categorized and explained under the following:
The first obvious difference between cash and trade discount stems from the origin of the discounts. This means situations where discounts are given to the customer by the seller. A trade discount is granted to the buyer when they purchase goods under the discount policy. Cash discount, on the contrary, is only allowed when the customer makes payments, especially if there is a credit.
These two discounts also differ on the grounds of which they are granted. As the trade discount relates to goods purchased or sales made, it depends on the amount of the first. The more goods the customer buys, the higher the price and the amount of discount offered. Conversely, the cash discount is based on the period of payment for the goods purchased. This therefore means that the earlier the customer makes the payment, the higher the rate and amount of the discount he or she will receive.
3. Record in Books of Accounts
There is a difference in the way a bookkeeper record these two types of discounts. The trade discount is not recorded in either of the credit or debit side of the cash book. The discount is deducted from the listed price of the purchased goods and entry on the sales and purchases is made in the books with the already reduced price of goods. A cash discount is, however, recorded in the book of accounts as discount. It is recorded on the debit side of the cash book by the seller as discount allowed and on the credit side of the cashbook by the buyer as discount received.
This is a difference in where the discount is deducted. Trade discount is deducted from the value of the invoice having the list price of the goods purchased. However, a cash discount is not deducted from the value of the goods on the invoice. On the contrary, the deduction of cash discount is recorded in the cash book as a discount allowed or received depending on whether it is the seller or the buyer respectively.
When tracking discounts, you need to know which discount is reflected and where. This means that you need to know if the discount is cash or trade. The trade discount is reflected in the sales or purchase book, again depending on whether it is the seller or the buyer, and is presented as a deduction from the sale price or the purchase price. The trade discount is not posted to the income statement. However, a cash discount can be found on both the cash book and the income statement. The discount cannot be carried over to sales or purchases books.
6. Discount Policy
This is usually a business decision and dictates how and how much the discount is granted. Generally, the trade discount is offered as a short-term means to promote sales and is permitted as part of the program advertised by the company. A discount may be allowed on certain products in order to promote their sales. A discount, however, may be allowed in cash when payments are made instantly rather than by credit - under the company's stated policy.
With all of this in mind, it is now easier to differentiate these two often confusing business terms. The differences between trade and cash discount stand out clearly as has been shown. The main difference between the two is that a trade discount is allowed based on the number of goods bought while cash discount is given based on the time needed to pay for the goods purchased.