The Advantages of Using a Sales Return & an Allowances Account Chron com
If a customer purchases merchandise and is dissatisfied with their purchase, they may receive a refund or a partial refund, depending on the situation. When the customer returns merchandise and receives a full refund, it is considered a sales return. When the customer keeps the defective merchandise and is given a partial refund, it is considered a sales allowance. The biggest difference is that a customer returns merchandise in a sales return and keeps the merchandise in a sales allowance.
As inventory is expected to be sold within a year, it is reported on the balance sheet as a current asset. If so, the company would record a decrease to Cost of Goods Sold (COGS) and an increase to Merchandise Inventory to return the merchandise back to the inventory for resale. This is recorded at the merchandise’s costs of goods sold value. If the merchandise is in sellable condition but will not realize the original cost of the good, the company must estimate the loss at this time.
Both Cash (asset) and Sales Revenue (equity) increase by the amount of sale ($600). The second journal records the effects of the sale on In Style Fashion’s inventory and expense. Cost of Goods Sold (expense) increases by the same amount as the cost of the inventory sold. You may have noticed our discussion of credit sales did not include third-party credit card transactions. This is when a customer pays with a credit or debit card from a third-party, such as Visa, MasterCard, Discover, or American Express.
Knowing how many customers are willing to accept a price cut on an item versus those who insist on a return is valuable information. These transactions are called allowances and sales returns, respectively, and are normally combined into one account, which has the effect of reducing gross sales. Choosing to split up sales returns and allowances so you have a distinct figure for each can reveal information to use in business planning. A business’ financial statements report the combined cost of all items sold as an offset to the proceeds from those sales, producing the net number referred to as gross margin (or gross profit). This is presented in the first part of the results of operations for the period on the income statement. The unsold inventory at period end is an asset to the company and is therefore included on the balance sheet.
Now, let’s look at the entry from Whistling Flute’s perspective. As the seller, Whistling Flute needs to show not only the return of the inventory but also the reduction in sales. Because we want to preserve the original sales data and track returns, we are going to use a contra account called Sales Returns and Allowances to record the revenue portion of the transaction. The value being returned to inventory is the cost that Whistling Flute paid for the inventory, which is $400. There are differing opinions as to whether sales returns and allowances should be in separate accounts. Separating the accounts would help a retailer distinguish between items that are returned and those that the customer kept.
Accounting For Purchase Returns
In this entry, inventory (asset) increases and so does accounts payable (liability). Let’s say a customer purchases 300 plants on credit from a nursery for $3,000 (with a cost of $1,200). Now, assume that the customer paid the retailer within the 30-day period but did not qualify for the discount. Revenues (sales) are reported first, followed by any period operating expenses. The outcome of sales less expenses, which is net income (loss), is calculated from these accounts. When using the periodic method, the entries for allowances are the same as entries for returns because we do not track inventory under the periodic method.
- The number of days allowed for both the discount period and the full payment period begins counting from the invoice date.
- There are several examples of purchase returns and allowances in daily business.
- For example, suppose a kitchen appliances retailer purchases merchandise for their store from a manufacturer on September 1 in the amount of $1,600.
This can better identify quality control issues, track whether a customer was satisfied with their purchase, and report how many resources are spent on processing returns. Most companies choose to combine returns and allowances into one account, but from a manager’s perspective, it may be easier to have the accounts separated to make current determinations about inventory. The sales discounts account is a contra revenue account that is deducted from gross sales at the end of a period in the calculation of net sales. Sales Discounts has a normal debit balance, which offsets Sales that has a normal credit balance. Sales discounts are incentives given to customers to entice them to pay off their accounts early. The discount serves several purposes that are similar to the rationale manufacturers consider when offering discounts to retailers.
Accounting of Sales Return and Allowances
In the case of an allowance, the physical inventory is not returned to the seller. The buyer gets to keep the merchandise but receives a discount on the merchandise. Sometimes this happens because the inventory is incorrect but the buyer thinks it can still be sold.
When a customer returns the merchandise, a retailer issues a credit memo to acknowledge the change in contract and reduction to Accounts Receivable, if applicable. The retailer records an entry acknowledging the return by reducing either Cash or Accounts Receivable and increasing Sales Returns and Allowances. Cash would decrease if the customer had already paid for the merchandise and cash was thus refunded to the customer. Accounts Receivable would decrease if the customer had not yet paid on their account. Like Sales Discounts, the sales returns and allowances account is a contra revenue account with a normal debit balance that reduces the gross sales figure at the end of the period.
If the baseball league decides to use a line of credit extended by the shoe store, the shoe store would debit Accounts Receivable as part of the sales entry instead of Cash. With the sales entry, the shoe store must also recognize the $900 cost of the shoes sold and the $900 reduction in Merchandise Inventory. It is possible to show these entries as one, since they affect the same accounts and were requested at the same time. An operating cycle is the amount of time it takes a company to use its cash to provide a product or service and collect payment from the customer.
One entry recognizes the sale and the other recognizes the cost of the sale. The sales entry consists of a debit to either Cash or Accounts Receivable (if paying on credit), and a credit to the revenue account, Sales. To recognize a return or allowance, the retailer will reduce Accounts Payable (or increase Cash) and reduce Merchandise Inventory. Accounts Payable decreases if the retailer has yet to pay on their account, and Cash increases if they had already paid and received a subsequent refund.
Should Sales Returns Be Deducted From Total Revenue?
For example, a clothing store may pay a jeans manufacturer cash for 50 pairs of jeans, costing $25 each. The general ledger may occasionally be comprised of a combination of the two accounts wherein they are aggregated into one. It usually occurs in the case that the balances in these accounts are not very substantive, thus eliminating the need for tracking returns and allowances separately. In returns and allowances accounting, this line item is presented as a subtraction from the gross sales line item. It is used to decrease sales by the number of product returns from customers and sales allowances granted. In the income statement, it comes before a net sales line item, which is a computation that aggregates the gross sales line item and the negative amount in the sales returns and allowances line item.
Under period inventory, we do not record changes in inventory until the end of the period, so this entry is fairly simple. This entry is very similar to the entry used under perpetual inventory, but instead of Inventory we use Purchase Returns and Allowances. Essentially, we are reversing a portion of the original purchase journal entry. It seems they were supposed to go to Jill’s Sporting Goods instead of Bill’s Bikes!
The net purchases item is what will be used when calculating the cost of goods sold at the end of the period. The net effect of these two entries on assets and equity is a $200 ($ ) increase which equal to the gross profit (Revenue $600 – Expense $400) that In Style Fashion earned on the sale. There are a few transactional situations that may occur after a sale is made that have an effect on reported sales at the end of a period. You may have noticed that sales tax has not been discussed as part of the sales entry. Sales taxes are liabilities that require a portion of every sales dollar be remitted to a government entity. This would reduce the amount of cash the company keeps after the sale.
Business owners may encounter several sales situations that can help meet customer needs and control inventory operations. For example, some customers will expect the opportunity to buy using short-term credit and often will assume that they will receive a discount for paying within a brief period. The mechanics of sales discounts are demonstrated later in this section. To illustrate, assume that Carter Candle Company received a shipment from a manufacturer that had 150 candles that cost $150. Assume that they have not yet paid for these candles and 100 of the candles are badly damaged and must be returned.
These entries and discussion are covered in more advanced accounting courses. As previously mentioned, a sale is usually considered a transaction between a merchandiser or retailer and a customer. When a sale occurs, a customer has the option to pay with cash or credit. For our purposes, let’s consider “credit” as credit extended from the business directly to the customer.
Otherwise, they have 30 days to pay in full but do not receive a discount. If the customer does not pay within the discount window, but pays within 30 days, the retailing company records a credit to Accounts Receivable, and a debit to Cash for the full amount stated on the invoice. If the customer is able to pay the account within the discount window, the company records a credit to Accounts Receivable, a debit to Cash, and a debit to Sales Discounts. Purchase discounts provide an incentive for the retailer to pay early on their accounts by offering a reduced rate on the final purchase cost. Receiving payment in a timely manner allows the manufacturer to free up cash for other business opportunities and decreases the risk of nonpayment. The first entry records the effect of the sale on In Style Fashion’s cash and revenues.
The debit to accounts payable reduces the purchases on the income statement in line with the contents of the purchase returns and allowances account. Gross sales is the original amount of the sale without factoring in any possible reductions for discounts, returns, or allowances. Once those reductions are recorded at the end of a period, net sales are calculated.
While this section will focus on how inventory is recorded using the perpetual system, we will demonstrate how cost of goods sold is calculated using both inventory systems in the next section. If the retailer does not pay within the discount window, they do not receive a discount but are still required to pay the full invoice price at the end of the term. In this case, Accounts Payable is debited and Cash is credited, but no reductions are made to Merchandise Inventory. The next section examines how businesses determines the cost of inventory sold, the ‘Cost of Goods Sold’ (sometimes also referred to as Cost of Sales, as is the case in CSL above). The nursery would also record a corresponding entry for the inventory and the cost of goods sold for the 100 returned plants.
How to Calculate Sales Returns in a General Ledger
The symmetry in these accounts is achieved through a debit, which is the converse of the original credit balance in the gross account. A purchase return occurs when merchandise is returned and a full refund is issued. A purchase allowance occurs when merchandise is kept and a partial refund is issued. In either case, a manufacturer will issue a debit memo to acknowledge the change in contract terms and the reduction in the amount owed. However, any additional goods for sale acquired during the month are recorded as purchases.