The term trade discount is used to describe the amount by which the list price of an item is reduced when selling to a business that will eventually resell the item. Trade discounts are used to mask the true invoice price from competitors, simplify pricing in brochures and catalogs, as well as reward high volume resellers.
Trade Price Paid = List Price - (Trade Discount x List Price)
Also referred to as a functional discount, a trade discount is offered by a wholesaler of an item to a retailer that will resell the item. Businesses will oftentimes standardize the discount offered to trade partners for several reasons, including:
- Promoting Loyalty: companies can increase the discount offered as the volume of the product purchased increases, thereby incenting the reseller to promote the company's product. For example, the discount might be 10% on purchases of less than 100 units per month, and 15% if more than 100 units are purchased.
- Simplifying Pricing: publishing separate trade discounts will simplify the pricing structure appearing in product catalogs and brochures, while providing the company the flexibility to change the discounts offered through separate updates.
- Masking Prices: publishing and quoting at retail or catalog prices makes it more difficult for competitors to learn the actual price paid by trade partners.
Accounting for trade discounts is straightforward. Revenue is recorded at the net amount appearing on the invoice, with a corresponding increase to accounts receivable or cash.
Company A's list price for a widget is $150, with a trade discount of 10% for orders of 10 or more widgets. Company XYZ places an order for 30 widgets with Company A. The invoice sent to Company XYZ would include: