Trade Discount is the reduction in the retail price of products that arises from bulk sales or purchases. Trade discounts are often granted to wholesalers who buy in high volumes.
Trade discounts are deducted outright from the product's listed price. Meaning, the seller records the sale at the price net of the trade discount. The buyer also records the purchase at net of the trade discount.
Trade discount is different from cash discount. Cash discounts are granted for early payment of an amount due. Cash discounts are recorded as "Sales Discount" by a seller. In the books of the buyer, it is recorded as "Purchase Discount" if the periodic inventory method is used of a deduction to inventory when under the periodic method.
Trade discounts are not reflected in the accounting system of both the seller and the buyer. The price is recorded at net of the trade discount.
ABC Company sold 1,000 boxes of juice drinks to DEF Company, a wholesaler. Each box contains 10 packs and each pack has a retail price of $0.50. DEF is granted a 40% trade discount. The entry to record the sale in the books of ABC would be:
The amount recorded under "Sales" is at net of the trade discount. The total amount at retail price is $5,000 (i.e. 1,000 x 10 x 0.50). The customer was granted a trade discount of 40%. Hence, sale is recorded at $3,000.
In the books of DEF, the journal entry would be (assuming the periodic inventory method is used):
Purchases in the books of the buyer is also recorded at net of the trade discount.