Accounting for Sales Return: Journal Entries and Example

On Feb 5, journal entry to record the sales return and the buyer’s account adjustment. Since sales returns and allowance are debited from gross sales, it has a negative balance. Therefore, due to the negative balance, these accounts are also called contra-revenue accounts. A contra-revenue account is a liability from revenue which helps in determining whether to omit certain sales transactions, which would otherwise be mistaken as revenue. It is usually included if there are any sales returns and allowances or other type of return not recorded in the sales journal.

How Sales Allowances Differ from Sales Returns

On 5th Feb 2020, the customer returned 5 pieces of product Y and 6 pieces of product Z to ABC cosmetics. Now we have to deal with inventory/goods that customers just returned. Once the buyer identifies these problems, the buyer will normally need to return the goods and then ask for returning cash or reducing the credit balance.

The company collects sales tax at 7% on all goods sold by it and periodically sends the collected amount of tax to a tax-collecting agency. Companies may offer sales allowances for various reasons, which include the following. Sales return isn’t exactly an expense or a loss to the company, however, it reduces current assets (in the case of credit sales), and therefore, it indirectly acts as a loss. See the entries below on how to record the goods returned by customers into the inventories and how it is affected the cost of goods sold. On Feb 2, the journal entry to adjust inventory and record cost of goods sold account.

The Importance of Recording Returns Promptly

• They’re integral in tracking the quality of your product, consumers’ satisfaction with your business, and the profitability of your sales efforts.
• In the financial statements, companies must present both of them.
• Sales allowances, on the other hand, are discounts given to customers for keeping such defective or unwanted products instead of returning them.
• On 1 July 2014, it sold 500 footballs each to Club A and Club B at a price of $20 per football.

They also influence your cost of goods sold, decreasing it as returned items are no longer considered sold. Accurate recording of these changes is essential to avoid inflating sales figures and misrepresenting inventory levels. By correctly accounting for returns, you gain a clearer picture of your true financial position, which is crucial for making strategic decisions and ensuring compliance. If you’re dealing with high-volume sales and returns, consider how automating this process can improve accuracy and efficiency.

So, when a customer returns something to you, you need to reverse these accounts through debits and credits. Because if you sell products at your business, you know that not all customers are satisfied. If a customer wants to bring back an item, you need to make sales returns and allowances journal entries. If a cash refund is made due to a sales return or allowance, the sales returns and allowances account is debited and the cash account is credited.

The second one is to record these transactions in a special journal known as the sales returns and allowances journal. The second approach is more convenient for companies that experience too many such transactions during the year. The sales returns and allowances journal is a special journal maintained to record the return of inventory from buyers or any allowance granted to them.

What is the accounting treatment of Sales Returns and Allowances?

They also create a liability on your balance sheet until processed, because the business owes the customer money. Proper accounting for refunds ensures these changes are reflected accurately, giving you a clear picture of your financial position. This accurate view is essential for making informed business decisions and maintaining compliance with regulations.

Treatment of Sales Returns in the Financial Statements

Similarly, the credit side for the entries will depend on how companies compensate their customers. The seller makes an adjusting entry in which the accounts payable account is debited and the sales returns and allowances account is credited. This journal entry ensures that payment has been received for the returned goods. When merchandise are returned by a credit customer, only one journal entry is required. The sales return and allowances account under the periodic inventory system is recorded the same way as under the perpetual inventory system.

Accounting for Sales Returns and Allowances

Therefore, when sales returns and allowances occur, companies have already recorded sales in the accounts. The accounting treatment of sales returns and allowances occurs after this period. Therefore, companies must account for them as a reduction in sales rather than credit the account with the amount. It is one of the similarities between sales returns and allowances. In the income statement, sales returns and allowances are subtracted from sales, along with any sales discounts, to calculate your net sales.

• In a company’s general ledger, both sales returns and sales allowances are recorded in a single account known as the sales returns and allowances account.
• Similar to a cash refund, you’ll debit the Sales Returns and Allowances account and credit the Cost of Goods Sold account.
• Therefore, if you receive a refund from a previous fiscal year, it’s recorded as revenue in the current fiscal year.
• Some companies do not use the contra-account for the purpose of sales return.
• Sales allowance arises when the customer agrees to keep the products at a price lower than the original price.

Schedule a demo with HubiFi to explore how our automated revenue recognition solutions can simplify these complexities. Understanding how to classify returns is crucial for accurate financial reporting. They also decrease assets (like cash or accounts receivable) and adjust both inventory (increasing it) and the cost of goods sold (decreasing it). Misclassifying returns can distort your financial statements and make it difficult to understand your business’s true performance. A clear understanding of how sales returns impact your financial health is essential for making sound business decisions.

Think minor defects, like a small scratch on a furniture piece, or perhaps the product isn’t quite the right shade of blue. A sales allowance is a price reduction you offer to a customer who keeps the merchandise despite a slight issue. It’s a way to keep the customer happy without processing a full return. This preserves the customer relationship and avoids the logistical hassle of sales return and allowances journal entry a return. For example, if a customer buys a dress for $100 but it has a loose button, you might offer a $10 sales allowance, and the customer keeps the dress.