What Is Sales Return?
Sales return is the return of products or commodities by customers to the seller due to many reasons, but usually within some agreed time period and due to the condition of the product and customer satisfaction. This sales return is accounted for differently from the seller and buyer’s perspectives. There may be countless reasons for sales return, but some of the common reasons are:
- Goods are defective
- Goods are not according to the customer’s needs
- Goods are shipped too late to the customer
- Wrong Products sent to the buyer
- Products are not according to the specifications
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.
In other words, the account payable in the buyers’ book is reduced.
But, how should this transaction be recorded and recognized in the seller’s book?
Should revenue decrease or remain the same?
Should the account receivable balance decrease or increase?
What if the good returns as cash sales? How do we account for it?
Journal Entries for Sales Return:
Accounting for sales return is mainly concerned with revising revenue and cost of goods sold previously recorded. Account receivable or cash and cash equivalents should also affect whether it is the cash sale or credit sales.
For the seller, revenue can be revised by debiting the sales return account (A contra account by nature) and crediting cash/accounts receivable with the invoice amount.
Here is the sale return journal entry:
|Sales Return Allowance / Revenue Account||XXX|
|Cr – Cash/Accounts Receivable||XXX|
As we can see from the journal entries above, the seller should debit the exact amount of return to the revenue account or the sales return allowance account once the sale is returned. This sales return allowance account is the contra account to the sales revenue account.
The other entry is the cash or account receivable. It depends on whether the sale of those goods that were returned were cash sales or credit sales.
If it were the credit sales, then we should credit to the account receivable account. If the sales were cash sales, we should credit them to the cash or bank account since the company will need to pay back to the customer. Either cash sale or credit, we need to reduce cash or account receivable accounts and reduce the revenues.
This is not finished yet.
Now we have to deal with inventory/goods that customers just returned.
These inventory/goods need to be stored and recorded in the warehouse.
So when the company’s warehouse physically receives the goods, the inventory account will be debited to increase the asset, and the cost of goods sold will be credited.
Here is the entry to recognize inventory and derecognition of the cost of goods sold.
|Inventory / Stock||XXX|
|Cost of Goods Sold||XXX|
So once this entry is posted, inventory will be increased, and the cost of goods sold will be derecognized.
Now let’s move to the example,
ABC cosmetics, A cosmetic distributor, deals in two products, Product Y and Product Z.
On 2nd Feb 2020, the firm recorded credit sales of 10 pieces for product Y and 15 pieces for product Z to one of its old customers for $50 and $25 each respectively.
On 5th Feb 2020, the customer returned 5 pieces of product Y and 6 pieces of product Z to ABC cosmetics.
The ABC cosmetics purchase product Y at $40 per piece and product Z at $20.
Show the general entries to record sales and sales return in the books of ABC cosmetics.
1. On Feb 2, the journal entry was to record the sales account and the account receivable account as follows:
Dr Account Receivable (ABC cosmetics) = $875
Cr Product Y sale (10*$50) = $500
Cr Product Z sales (15*$25) = $375
Since this is the credit sales, the company needs to account for the account receivable by debit in the amount of USD875 and credit to sale account USD500 and USD375 and giving the total of USD875.
Once sales are made, not only sale revenue and account receivable are affected by this transaction. The goods will deliver to the customer, and the inventories will reduce.
Finish goods will reduce specifically. The other account that will be affected the same amount as finished goods is the cost of goods sold.
Let’s see the following transaction,
2. On Feb 2, the journal entry to adjust inventory and record cost of goods sold account.
Dr – Cost of Goods sold = $700
Cr – Product Y (10*$40) = $400
Cr – Product Z sales (15*$20) = $300
As per the example above, the customer returns the goods that were sold to them on 5 Feb. 5 pieces of product Y and 6 pieces of product Z. Here are the entries to record these sales returns,
3. On Feb 5, journal entry to record the sales return and the buyer’s account adjustment.
Dr Sales Return Allowance / Revenue (5*50) = $250
Dr Sales Return Allowance / Revenue (6*25) = $150
Cr Account Receivable (ABC Cosmetics) = $400
So we debit the Sales Return Allowance or the Revenues Account at USD250 plus USD150 and debit Account Receivable. We could not credit cash since it is not cash sales.
As we know, the customer returns the goods to the company. We will need to keep the returned goods in the company’s warehouse and reflect this transaction correctly in the accounting records.
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.
4. On Feb 5, journal entry to update the inventory account.
Dr Product Y (5*$40) = $200
Cr Product Z sales (6*$20) = $120
Cr Cost of Goods Sold = $320
When preparing an income statement, the amount in the sales return allowance is deducted from the total sales to calculate the company’s actual sales/net sales.
Sales returns and allowances:
Normally sales returns and allowances are two different kinds of transactions. Still, the accounting treatment for both the transactions is the same, and mostly the same account is used to record both types of transactions.
Sales returns occur when a customer returns goods to the seller due to some fault, while the term sales allowance is used when the buyer agrees to keep the products, but for a lesser price.
See the table below on it is present and affects the total revenue in the income statement:
|Gross Sales Revenues||XXX|
|Les sales returns and allowances||(XXX)|
|Net Sales revenues||XXX|
Are sales returns and allowances an expense?
Sales returns and allowance are the contra account to the sales revenues where the previously recognized sales need to be derecognized by recording into this account.
It is not the expenses account, but it is the contra account to the sales revenue to reduce the gross sale revenue to the net sale which you could trace back with the net sales in the income statement.
Are sales return a debit or credit?
Sales revenue is the income statement account, and it is recognized when the control is passed to customers. Sales revenue is increasing in credit and decreasing in debit accounts. The sale return account is created for recording the sale that is returning from the customer. It is the contra entries of the sales account, increasing in debit and decreasing in credit. The main reason that is recording in debit while the sales return happened is that this account will decrease the total sale revenue.