A trade discount is a reduction in price a manufacturer or wholesaler gives a wholesale or retail when they buy a product or group of products. It is short of rebate or allowance is given by the seller to the buyer of goods as a custom of the trade or when the buyer buys goods in bulk. It is a discount allowed on a product as a reduction to the retail price. It is the amount by which a manufacturer or wholesaler reduces the price of a product when it sells the product to a reseller. As the trade-discount is deducted before any exchange takes place, it does not form part of the accounting transaction and is not entered into the accounting records of the business.
A trade discount is different than a sales discount because a trade discount does not have the same restrictions as a purchase discount. The reseller does not necessarily resell at the suggested retail price; selling at a discount is a common practice if the reseller wishes to gain market share or clear out excess inventory. The use of trade discounts allows a company to vary the final price based on each customer’s volume or status. For example, a high-volume wholesaler might be entitled to a higher discount compared to a medium or low-volume wholesaler. Usually, a retail customer will not receive any discount and will have to pay the entire published price.
Trade discounts are usually given to wholesalers that order large quantities of a product as well as retailers with good relationships with the manufacturer. It is different from a cash discount. It usually varies with the quantity of the product purchased. Cash discounts are granted for early payment of an amount due. Cash discounts are recorded as “Sales Discount” by a seller. It is a reduction in the published price of the product. Purchase discounts or cash discounts are based on payment plans, not order quantities. In the books of the buyer, it is recorded as “Purchase Discount” if the periodic inventory method is used for a deduction to inventory when under the periodic method.
For example, ABC International offers its resellers a trade discount. The retail price for a green widget is $2. One reseller orders 500 green widgets, for which ABC grants a 30% trade discount. Thus, the total retail price of $1,000 is reduced to $700, which is the amount that ABC bills to the reseller. The trade discount is therefore $300.