Trade Discount vs Cash Discount: Definitions, Calculation, and Journal Entries
Discounts in commerce are reductions in the price of goods or services offered to purchasers. They not only boost sales but also help businesses maintain strong relationships with buyers. There are two primary types commonly used in business transactions—trade discount and cash discount. Understanding the difference between these two is essential for students of accounting and business, as it affects invoicing, accounting records, and financial calculations.
What is a Discount?
A discount is a reduction made from the original price of a product or service. Sellers often offer discounts to attract customers, increase sales, or ensure quicker collection of payments. Discounts can vary in purpose and application, but they always involve lowering the price paid by the buyer.
Types of Discounts in Business Transactions
In business, the two main types of discounts are:
- Trade Discount: A deduction in the listed (catalogue) price offered by a seller to resellers such as wholesalers or retailers, generally for bulk purchases.
- Cash Discount: A reduction given by the seller to the buyer on the invoice amount, as an incentive for prompt or immediate cash payment.
Both types help in promoting the business but are applied at different stages and for different reasons.
Trade Discount: Meaning and Explanation
A trade discount is the reduction in the catalogue price a seller provides to a buyer, usually when goods are purchased in large quantities. The main purpose is to encourage bulk buying and to strengthen business-to-business relationships. Trade discounts are not recorded separately in the accounting books; only the net amount (after the discount) is entered.
For example, a manufacturer might offer a trade discount to wholesalers or retailers who purchase products in bulk, thus creating an incentive for large-volume orders.
Formula for Trade Discount
There are two common ways to calculate a trade discount:
- Amount: List Price – Discount Amount
- Percentage: Trade Discount = List Price × Trade Discount Percentage
Example of Trade Discount
Suppose the catalogue price of 100 handmade soaps is ₹1,000 each. If a trade discount of 10% is offered, the calculations would be:
- Total price = ₹1,000 × 100 = ₹1,00,000
- Trade Discount = ₹1,00,000 × 10% = ₹10,000
- Net amount payable = ₹1,00,000 − ₹10,000 = ₹90,000
The buyer pays ₹90,000, and the price per soap becomes ₹900. Trade discounts are always deducted before any further calculations such as cash discounts or taxes.
Cash Discount: Meaning and Explanation
A cash discount, also called a sales discount, is a concession granted to buyers for making prompt or immediate payment. This encourages buyers to settle invoices quickly, improving the business’s cash flow. Unlike trade discounts, cash discounts are recorded in the books of accounts.
Cash discounts are given on the net invoice value after deducting trade discounts and are especially useful for final settlement of dues.
Formula for Cash Discount
Cash Discount = Net Invoice Value × Rate of Cash Discount
Final Payment Amount = Net Invoice Value − Cash Discount
Example of Cash Discount
If the purchase price is ₹3,000 and a cash discount of 15% is offered for immediate payment:
- Cash discount = ₹3,000 × 15% = ₹450
- Final payment = ₹3,000 − ₹450 = ₹2,550
This discount applies only if payment is made within the allowed period or instantly.
Step-by-Step Calculation: Combined Example
Let’s understand how both discounts are applied with a complete example:
- List Price of goods = ₹20,000
- Trade Discount = 10% of ₹20,000 = ₹2,000
- Net Invoice Value = ₹20,000 – ₹2,000 = ₹18,000
- Cash Discount = 5% of ₹18,000 = ₹900
- Final Payment = ₹18,000 – ₹900 = ₹17,100
| BASIS | Trade Discount | Cash Discount |
|---|---|---|
| Purpose | Encourage bulk purchases | Encourage prompt payment |
| When Allowed | At time of sale/invoice | At time of payment |
| Entry in Accounts | Not recorded | Recorded |
| Calculated On | Catalogue/List Price | Net Invoice Value after trade discount |
| Shown on Invoice | Yes, as deduction | Usually not shown, sometimes noted as a footnote |
| Who Benefits | All eligible bulk buyers | Only buyers paying on time or in cash |
| Application | Both cash and credit transactions | Only on cash transactions |
Common Applications and Best Practices
- Always deduct trade discount before computing cash discount.
- Record cash discount in the accounting books but never record trade discount.
- Use discount strategies to manage inventory and improve cash flow.
Practice Questions
- On goods worth ₹40,000, a trade discount of 10% and a cash discount of 2% are given for immediate payment. Calculate the payment made by the buyer.
- Distinguish between trade discount and cash discount using two points each.
- If a customer receives a cash discount of ₹900 for prompt payment of an ₹18,000 invoice, what journal entry should be passed by the seller?
Next Steps for Learning
- Practice discount calculations and journal entries for different transaction scenarios.
- Explore advanced accounting concepts with more Vedantu commerce resources.
Understanding the distinction between trade and cash discounts helps in accurate invoice preparation, financial analysis, and error-free accounting—skills that are valuable for commerce students and aspiring accountants alike.
FAQs on Difference Between Trade Discount and Cash Discount Explained
1. What is the main difference between trade discount and cash discount?
The main difference lies in their purpose and timing:
- Trade discount is given for purchasing in bulk or at the time of sale and is deducted from the list price.
- Cash discount is offered for prompt or early payment and is deducted from the invoice value after trade discount.
Trade discounts are not recorded in accounting books, while cash discounts are recorded as ‘Discount Allowed’ or ‘Discount Received.’
2. Can a sale have both trade and cash discounts?
Yes, a single transaction can involve both discounts:
- First, trade discount is applied to the list/catalogue price, reducing the invoice value.
- Then, cash discount is calculated on the reduced invoice value if payment is made within the specified period.
This is commonly used in wholesale trade transactions.
3. Why are trade discounts not recorded in the books of accounts?
Trade discounts are not recorded because:
- They reduce the sale/purchase value before any transaction is entered in the books.
- Only the net amount after trade discount appears in invoices and accounting records.
- Thus, there is no need to pass a separate entry for trade discounts.
4. On what basis are trade discounts and cash discounts given?
Trade discount: Given for purchasing large quantities, on the list or catalogue price.
Cash discount: Given for making prompt or early payment, calculated on the net invoice value after trade discount has been applied.
5. How are trade discount and cash discount shown on invoices?
Trade discount is clearly shown and deducted in the invoice itself.
Cash discount is usually mentioned as discount terms (e.g., “5% if paid within 10 days”) and is not shown as a deduction in the invoice amount; it is reflected only if prompt payment is made.
6. What is the journal entry for allowing cash discount?
When cash is received from a debtor and a cash discount is allowed, the entry is:
Cash A/c Dr.
Discount Allowed A/c Dr.
To Debtors A/c
This records actual cash received and the discount allowed.
7. Which discount impacts GST or taxable value?
Trade discounts (if given before or at the time of supply and mentioned in the invoice) reduce the GST taxable value.
Cash discounts (given after supply) are not deducted from taxable value for GST calculation.
8. What is the formula for calculating trade discount and cash discount?
Trade Discount Formula:
Trade Discount = List Price × Trade Discount %
Cash Discount Formula:
Cash Discount = Net Invoice Amount × Cash Discount %
Always apply trade discount first, then cash discount.
9. Is trade discount allowed in both cash and credit transactions?
Yes, trade discount can be allowed for both cash and credit sales, provided the sale meets the criteria such as minimum bulk quantity or list price as per seller’s policy.
10. Who is eligible for a cash discount?
A cash discount is available only to buyers who pay the invoice amount promptly, within the period specified by the seller (e.g., within 7 or 10 days).
11. What type of account is ‘Discount Allowed’ and how is it shown in accounts?
‘Discount Allowed’ is an expense account or indirect expense for the business. It appears on the debit side of the Profit & Loss Account or Statement of Profit and Loss.
12. List two main differences between trade discount and cash discount.
Two key differences are:
- Trade discount is not recorded in the books of accounts; cash discount is always recorded.
- Trade discount is given for bulk purchases; cash discount is given for quick payment.
