Accounting for Sales Returns

Customers are normally entitled to return the products they purchased from a company when they are not satisfied. When a sales return occurs, the customer physically returns the product and receives his cash back.

Accounting for a sales return involves reversing (a) the revenue recorded at the time of original sale, and (b) the related cost of good.

Revenue is reversed by debiting the sales returns and allowances account (which is a contra-account to sales) by the amount of original sale and crediting accounts receivable account or cash account (depending on whether it was a credit sale or a cash sale).

Sales returns and allowancesA
Accounts receivable/cashA

Net sales equal gross sales minus sales returns and allowances.

Some companies do not use the contra-account for the purpose of sales return. Instead, they debit the sales account directly and credit accounts receivable or cash.

SalesB
Accounts receivable/cashB

When a product is physically returned, it increases inventory and decreases related cost of goods sold recognized at the time of sale. The following journal entry is made.

InventoryC
Cost of goods soldC

Example

Brazuca, Inc. is a football manufacturer and distributor. On 1 July 2014, it sold 500 footballs each to Club A and Club B at a price of $20 per football. Club A paid the total amount due (which was $10,000) on 10 July 2014. The receivable from Club B was outstanding as at the end of July, when Club A returned 5 and Club B returned 10 footballs. Each football costs $15.

Record the return of footballs by each club. How will the journal entries be different is no contra-account is used?

Solution

Sales return from Club A:

Sales returns and allowances [= 5 × $20]$100
Cash$100

Related cost of goods sold adjustment:

Inventory [= 5 × $15]$75
Cost of goods sold$75

Sales returns from Club B:

Sales returns and allowances [= 10 × $20]$200
Accounts receivable$200

Related cost of goods sold adjustment:

Inventory [= 10 × $15]$150
Cost of goods sold$150

Please note that accounts receivable is credited in case of Club B because the amount was still outstanding at the time of the sales return.

If no sales returns and allowances account is there, the revenue reversal entries will be different (as shown below). The cost of goods adjustment is same under both the methods.

Sales [= Club A + B = 100 + 200]$300
Accounts receivable [for Club B]$200
Cash [for Club A]$100

Written by Obaidullah Jan, ACA, CFA <--- Hire me on Upwork