Revenues define the income from a company’s operations during an accounting period. These revenues may arise from the sale of either goods or services. Similarly, they may come from both cash and credit sales. Regardless of their source, revenues play a significant role in a company’s profits and success. Therefore, companies strive to increase the numbers as high as possible.
Companies use various tactics to increase their sales and revenues. As mentioned, some companies offer credit sales which can increase these numbers. Some others may also provide customers with various allowances or offer them sales returns. Both of these also help companies boost their revenues. Before understanding how to record sales returns and allowances, it is crucial to define what these are.
What is a Sales Return?
Companies that sell physical goods may also offer sales returns policies. Usually, these companies produce the goods or acquire them from an external source. After production or acquisition, they hold these goods as inventory until customers order them. Once ordered, companies may deliver the goods or request customers to get those goods from a warehouse.
During this process, the goods may go under physical changes or deformities. Once customers receive the products, they may not work as intended or suffered damages. Therefore, customers will return those goods to a company. In exchange, the company will compensate the customers by repaying them or selling them other products. The company that receives the goods back must return them as sales returns.
Therefore, sales returns are goods that customers return to a company. In other words, it is the goods received from a customer due to various reasons. Usually, companies have a policy that states whether they accept goods returned by customers. Similarly, it will include the terms and conditions for which the returns will be acceptable.
Some of the reasons why customers may return goods will include the following.
- Faulty or damaged goods on delivery.
- Bought more than what they needed.
- Ordered by error.
- Received the wrong order or product.
- Found better quality or price elsewhere.
- Received goods late or after they needed them.
What is a Sales Allowance?
A sales allowance is a reduction in the price of goods charged by a company. However, it does not imply it is a trade or cash discount. Instead, companies offer a sales allowance after when it makes sales. Trade discounts usually involve a reduction in price before the sale occurs. Similarly, a sales allowance does not entail a discount for an early payment, which is what cash discounts are.
A sales allowance is similar to a sales return in one aspect. It occurs after a company makes a sale. However, companies offer sales allowances before the customer pays for them. However, customers do not return the goods sold to them. Instead, they keep those goods while also receiving a reduction in price for them. Like sales returns, companies have to record sales allowances separately.
In short, a sales allowance does not involve a physical return of goods. Instead, companies allow a specific deduction from the original price agreed with customers. These features differentiate sales allowances from sales returns. However, it still affects a company’s revenues in its financial statements. In that regard, it is similar to sales returns.
Companies may offer sales allowances for various reasons, which include the following.
- Higher price charged by the company.
- Problem with the sold product or service (usually quality issues).
- Short shipments.
- Price disagreements between the company and customers.
What is the accounting treatment of Sales Returns and Allowances?
Both sales returns and allowances represent a reduction in a company’s revenues after it makes sales. The accruals concept requires companies to account for revenues when they occur. Therefore, companies must not treat these transactions on cash settlement. Instead, they must record it as soon as the transaction happens. Usually, companies record sales in the books when they deliver goods to customers.
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.
Sales returns and allowances are contra revenue accounts in the financial statements. A revenue account is a credit account. However, a contra revenue account is a debit account. Contra revenue accounts coexist with revenue accounts. In the financial statements, companies must present both of them. Usually, companies provide a breakup of the contra revenue account to calculate the net sales figure in the income statement.
Like other contra accounts, the contra revenue account goes against revenues in the income statement. Sales returns, allowances and discounts are some of the examples of this type of contra account. Some companies may keep these accounts together due to their similar nature. However, others will separate them into two accounts for better presentation and processing.
How to record Sales Returns and Allowances?
Recording sales returns and allowance is straightforward after knowing their accounting treatment. However, it is crucial to understand how companies account for their sales first. When a company sells a product or service to a customer, it will use the journal entries below.
|Cash or Accounts Receivable||XXXX|
Sales or revenues is a credit account due to its nature of being an income or increase in equity. However, sales returns and allowances are contra revenue accounts. Instead of being a credit, these are debit accounts. Similarly, the credit side for the entries will depend on how companies compensate their customers.
Usually, companies offer to exchange any sales returned. Companies do not record this transaction as it does not affect the sales or sales return. It is because the net effect for this entry is nil. However, it will impact the company’s inventory. The company will record the amount as a reduction in inventory.
If a customer does not agree to exchange goods, the company will repay them or reduce their receivable balance. Thus, the accounting treatment will be as follows.
The accounting entries for sales allowances will be the same. Instead of debiting the sales returns account, companies will debit the sales allowances account.
Companies must also present the sales returns and allowances figures in the financial statements. Usually, these are a part of the net sales calculation in the notes to the financial statements. The presentation will be as follows.
|Less: Sales Returns||(XXXX)|
|Less: Sales Allowances||(XXXX)|
A company, ABC Co., sold goods worth $100,000 to another company, XYZ Co. The accounting entries for the transaction were as follows.
|Accounts Receivable (XYZ Co.)||$ 100,000|
During the same period, ABC Co. made sales of $200,000 to another customer, RST Co. The accounting entries to record revenues from the transaction were as follows.
|Accounts Receivable (RST Co.)||$ 200,000|
After assessing the goods, XYZ Co. returned products worth $50,000 as they suffered damages during the delivery. ABC Co. compensated XYZ Co. for the returns by reducing its accounts receivable balance. The journal entries for sales returns from XYZ Co. are as follows.
|Sales Returns||$ 50,000|
|Accounts Receivable (XYZ Co.)||$ 50,000|
Similarly, RST Co. found some goods to be faulty. However, it agreed to keep the goods for a price reduction. ABC Co. offered the company a $30,000 sales allowance, which the customer accepted. Therefore, the journal entries for sales allowances provided to RST Co. are as follows.
|Sales Allowances||$ 30,000|
|Accounts Receivable (RST Co.)||$ 30,000|
At the end of the period, ABC Co.’s net sales on its financial statements were as follows.
|Less: Sales Returns||$ (50,000)|
|Less: Sales Allowances||$ (30,000)|
|Net Revenues||$ 220,000|
Sales returns are goods that customers return to a company due to various reasons. Sales allowances are discounts offered to customers after a company makes sales. However, these do not trade or cash discounts. Both accounts are contra revenues accounts and result in a reduction of a company’s revenues. The accounting treatment for both sales returns and allowances is similar.