Trade discount, Cash Discount and VAT

Question 1

What is the purpose of a trade discount?

Answer 1

This is given to encourage customer loyalty and to encourage customers to buy in bulk.

Question 2

Describe trade discount

Answer 2

It is shown on an invoice/credit note as a deduction from the value of the goods in order to find the Net Goods Value before VAT is added. It will therefore reduce how much the customer has to pay for the goods.

Question 3

What is the purpose of a cash discount?

Answer 3

This is given to encourage customers to pay promptly. (they do not have to pay by cash.)

Question 4

Describe cash discount.

Answer 4

If we receive cash discount then this is discount received-shown as other income in the income statement.
If we give/allow cash discount to our customers then this is discount allowed which is shown as an expense in an income statement.
Unlike trade discount, cash discount is shown as a deduction on the “Illustrative” invoice or credit note only and will affect the VAT calculation.
Cash discount is shown in the ledgers as either discount received or discount allowed.

Question 5

Describe VAT.

Answer 5

This stands for “value added tax”. It is a tax which is added to the net goods value of goods. This will increase the total price customers have to pay for many of the goods they purchase.
It is shown on the documents and also recorded in the ledgers as you must know how much VAT must be paid to custom and Excise/Govt or claimed back.