The idea of giving a trade discount is frequently used in the supply chain. A trade discount is usually a percentage reduction in the price of merchandise granted by the manufacturer to the wholesaler or the wholesaler to the retailer. This discount is usually offered when a purchaser meets certain conditions to qualify for such a discount, i.e. based on the volume of product purchased.
The trade discount strategy aims to obtain the voluntary consent of the reseller to cooperate with the manufacturer and to sell as much of the product as possible. The financial benefit would be large sales without the need for making any further efforts to sell the product to the actual consumer and all the associated costs that reduce the income.
The downside of such a strategy can be the loss by the manufacturer of actual control over the sale of its products and dependence on an intermediary. If the manufacturer sets the goal of increasing sales and maintaining the required level of stock, then the distributor or wholesaler receives trade discounts to motivate the buyer to purchase from this particular manufacturer and, usually, in large quantities.
In most cases, the wholesaler recommends to the buyer the price it should charge for the product to the customers. This recommended price by the wholesaler is called the list price or suggested retail price. The discount is subtracted from the list price to obtain the net price. The net price is the price the retailer actually pays for the merchandise.
To calculate the trade discount and the net price, your accounting department should use the following formulas:
Trade Discount = List Price x Trade Discount Rate
Net Price = List Price – Trade Discount
Let’s say you own a retail store that sells candies. A candy wholesaler your business works with offers a 15% if you buy 10 boxes of candies and an 18% discount if you buy more. You decide to buy candies in bulk and order 15 boxes of candies.
Instead of paying the $50 price for each box of sweets if you did not take advantage of the trade discount, you will pay $41 per box because the trade discount will equal $50 x 18% or $9. Note that there is no need for the seller or the buyer to make an accounting entry in the books of accounts in the case of a trade discount.
Author: Charles Lutwidge