Companies grant discounts for customers in order to provide incentives for them to purchase more products. This is a widely utilized sales technique in all types of organizations and, trade discount and settlement discount are two main types of discounts granted. Trade discount is given at the time of conducting the sale while settlement discount is allowed at the time of payment. This is the key difference between trade discount and settlement discount.
CONTENTS
1. Overview and Key Difference
2. What is a Trade Discount
3. What is a Settlement Discount
4. Side by Side Comparison – Trade Discount vs Settlement Discount
5. Summary
What is a Trade Discount
A trade discount is a discount given by the seller to the buyer at the time of making a sale. This discount is a reduction in the list prices of the quantity sold. The main objective of trade discount is to encourage customers to purchase company’s products in more quantities. Trade discounts can be commonly seen between companies who sell products business to business (B2B). Since trade discount is a reduction from list price, it will not be recorded in the accounts.
E.g. Company A is a manufacturer of washing machines and sells them to Company C to be sold to the end customer. Company A charges a selling price of $25,000 per washing machine from Company C. However, if the number of washing machines bought by Company C exceeds 3,000 a year, Company A grants a discount of 10% (reduction in price of $2,500) for every additional washing machine sold
What is a Settlement Discount
Settlement Discount is a discount granted for customers at the time of purchase when cash is paid to complete the business transaction. Due to this reason Settlement Discounts are also referred to as ‘cash discounts’. Settlement discounts are widely seen in Business to Customer (B2C) transactions where the product is sold to the end customer.
E.g. Company X is a clothing retailer, and it grants a 15% discount for customers who buy clothing items within a selected date range in festive season.
Settlement Discounts are also seen in business to business markets. Many companies sell products on credit where their customers pay funds due at a future date. Such customers are referred to as ‘accounts receivables’ for the company which is recorded as a current asset. The longer the customers take to settle the company, the funds are tied up; thus, the company may face liquidity issues. Therefore, the main purpose of offering settlement discount is to encourage customers to settle debts early.
E.g. ABC Ltd offers 5% discounts for customers who settle their debts within a two-week period from the date which sale is conducted. T is a customer of ABC Ltd and purchases products worth of $7,000. ABC Ltd. will record the sale as per below.
Cash A/C DR$6,650
Discounts allowed A/C DR$350
Sales A/C CR$7,000
Figure 1: Allowing discounts is a commonly practiced strategy by many businesses
What is the difference between Trade Discount and Settlement Discount?
Trade Discount vs Settlement Discount |
|
| Trade discount is given at the time of conducting the sale. | Settlement discount is allowed at the time of payment. |
| Purpose | |
| Trade discounts are allowed to encourage customers to purchase products in larger quantities. | Settlement discounts are allowed to ensure that customers settle debts within a short period of time. |
| Accounting Entry | |
| No accounting entry is entered for trade discount. | Accounting entry is required for settlement discount. |
| Time | |
| Trade discount is allowed at the time of conducting the sale. | Settlement discount is allowed when the payment is made. |
Summary – Trade Discount vs Settlement Discount
The difference between trade discount and settlement discount basically depend on the time of granting the discount. Both these types of discounts are ultimately aimed at increasing the sales revenue and maintaining favourable relationships with customers. However, such discounts have the disadvantage of reducing profit margins since the companies should ensure that the benefits received from granting discounts exceed the costs.
Reference:
1.Studios, Nologo. “Add-on Products.” Customer Settlement Discounts. N.p., n.d. Web. 08 Mar. 2017.
2.”What is a trade discount? | AccountingCoach.” AccountingCoach.com. N.p., n.d. Web. 08 Mar. 2017.
3.”Difference/Distinction Between Cash Discount And Trade Discount”. College Accounting Coach. N.p., n.d. Web. 08 Mar. 2017.
Image Courtesy:
1. “Drogheda – Fair Deal Discount Store” by William Murphy (CC BY-SA 2.0) via Flickr