How to Record a Sales Return for Accounting
Once you get the hang of which accounts to increase and decrease, you will be able to record purchase returns and allowances in your books. A high or increasing percentage can reduce profits and undermine operational efficiency.
A debit increases accounts receivable, which is an asset account. Unlike an asset account, sales revenue is increased by a credit. For example, assume your small business sold $100 in products to a customer who will pay the invoice at a later date. Debit $100 to accounts receivable and credit $100 to the sales revenue account.
Sales Returns and Allowances Journal Entries
The discount allowed journal entry will be treated as an expense, and it’s not accounted for as a deduction from total sales revenue. All income statement accounts and the income summary account are reduced to zero and net income for the year of $2,034 is transferred to retained earnings. Purchases, Purchase Discounts, and Purchase Returns and Allowances (under periodic inventory method) are also temporary accounts.
These accounts normally have credit balances that are increased with a credit entry. The process of recording closing entries for service companies was illustrated in Chapter 3.
Since expenses are usually increasing, think “debit” when expenses are incurred. Debit the accounts receivable account in a journal entry in your records by the full invoice amount of a sale before a cash discount. Credit the sales revenue account by the same amount in the same journal entry.
The Income Summary account is closed to the Retained Earnings account. The effect is to transfer temporary (income statement) account balances in the income summary totalling $4,034 to the permanent (balance sheet) account, Retained Earnings. In an income statement, “sales” is classified as a revenue account and is posted as a credit entry in a double-entry bookkeeping system.
Basically, the cash discount received journal entry is a credit entry because it represents a reduction in expenses. At the end of a fiscal year, the balances in temporary accounts are shifted to the retained earnings account, sometimes by way of the income summary account. The process of shifting balances out of a temporary account is called closing an account. This shifting to the retained earnings account is conducted automatically if an accounting software package is being used to record accounting transactions. In the sales revenue section of an income statement, the sales returns and allowances account is subtracted from sales because these accounts have the opposite effect on net income.
Classification and Presentation of Sales Returns and Allowances
“Sales” is a nominal account because it represents business revenue. Nominal accounts are closed at the end of each accounting year to allow such accounts to start the next accounting year with zero balances. Since cash was paid out, the asset account Cash is credited and another account needs to be debited. Because the rent payment will be used up in the current period (the month of June) it is considered to be an expense, and Rent Expense is debited.
Accounting events related to goods being returned are documented in the final accounts as they have a monetary impact on the financial statements of a company. Depending on the terms and conditions of a transaction, goods sold both in cash and credit may be returned. Revenues are what businesses earn through selling their products to their customers while expenses are what businesses spend in the course of running their operations. For most businesses, the sales revenue that comes from their main operation is the main source of their revenues.
To close Sales, it must be debited with a corresponding credit to the income summary. Sales Discounts and Sales Returns and Allowances are both contra revenue accounts so each has a normal debit balance. Cost of Goods Sold has a normal debit balance because it is an expense.
- To close Sales, it must be debited with a corresponding credit to the income summary.
There are two primary types of discounts that might occur in your small business — trade discounts and cash discounts. A trade discount occurs when you reduce your sales price for a wholesale customer, such as on a bulk order. This type of discount does not appear in your accounting records or on your financial statements. A cash, or sales, discount is one you offer to a customer as an incentive to pay an invoice within a certain time. You must record cash discounts in a separate account in your records and report the amount on your income statement.
Their balances are transferred to the income summary account. All income statement accounts with credit balances are debited to bring them to zero. Debits increase asset and expense accounts, and decrease revenue, liability and shareholders’ equity accounts.
If the payment was made on June 1 for a future month (for example, July) the debit would go to the asset account Prepaid Rent. Expenses normally have debit balances that are increased with a debit entry.
A credit to a liability account increases its credit balance. Whenever cash is received, the asset account Cash is debited and another account will need to be credited. Since the service was performed at the same time as the cash was received, the revenue account Service Revenues is credited, thus increasing its account balance. Except for trade discounts — which are not recorded in the financial statements, these discounts appear as a credit on the income statement in the Profit and Loss Account.
Another difference between the two lies in how they are recorded in the financial statements. Discounts allowed represent a debit or expense, while discount received are registered as a credit or income. Both discounts allowed and discounts received can be further divided into trade and cash discounts.
Credits decrease asset and expense accounts, and increase revenue, liability and shareholders’ equity accounts. Debits and credits increase and decrease the “sales returns and allowances” account, respectively, because it is a contra account that reduces the sales amount on the income statement. We now offer eight Certificates of Achievement for Introductory Accounting and Bookkeeping. Revenues and gains are recorded in accounts such as Sales, Service Revenues, Interest Revenues (or Interest Income), and Gain on Sale of Assets.
At the end of the accounting year the balances will be transferred to the owner’s capital account or to a corporation’s retained earnings account. All income statement accounts with debit balances are credited to bring them to zero.
Identifying which products contribute to sales returns and allowances and addressing the underlying problems can minimize deductions from sales. A sales transaction is the most important type of transaction in any business because it provides the cash that pays for all business expenses and is the source of profits.
Net sales revenue is equal to gross sales revenue minus sales discounts, returns and allowances. Revenue accounts – all revenue or income accounts are temporary accounts. These accounts include Sales, Service Revenue, Interest Income, Rent Income, Royalty Income, Dividend Income, Gain on Sale of Equipment, etc. Contra-revenue accounts such as Sales Discounts, and Sales Returns and Allowances, are also temporary accounts.
Are sales returns and allowances on the income statement?
Sales Returns and Allowances is a contra-revenue account deducted from Sales. It is a sales adjustments account that represents merchandise returns from customers, and deductions to the original selling price when the customer accepts defective products.
To close these debit balance accounts, a credit is required with a corresponding debit to the income summary. “Temporary accounts” (or “nominal accounts”) include all of the revenue accounts, expense accounts, the owner’s drawing account, and the income summary account. Generally speaking, the balances in temporary accounts increase throughout the accounting year.
Therefore, sales returns and allowances is considered a contra‐revenue account, which normally has a debit balance. Recording sales returns and allowances in a separate contra‐revenue account allows management to monitor returns and allowances as a percentage of overall sales. High return levels may indicate the presence of serious but correctable problems. The first step in identifying such problems is to carefully monitor sales returns and allowances in a separate, contra‐revenue account. If you’re new to accounting, you may wonder how to record discounts allowed.
Sales returns and allowances are posted in the income statement as deductions from revenue and are recorded as debit entries in the company’s books. Along with sales discounts, the amount of sales returns and allowances is shown as a direct deduction from sales figures in the income statement to produce net sales. As noted earlier, expenses are almost always debited, so we debit Wages Expense, increasing its account balance. Since your company did not yet pay its employees, the Cash account is not credited, instead, the credit is recorded in the liability account Wages Payable.
AccountDebitCreditSales Returns and AllowancesXAccounts ReceivableXThe entries show that as your returns increase, your assets decrease. While you don’t lose physical cash, you do lose the sale amount. You need to record a sales return journal entry in your accounting books. To account for a return, reverse the revenue and cost of the good recorded in the original sale. In accounting parlance, nominal accounts are transactions that report revenues, expenses, gains and losses.
Cash discounts will go under Debit in the Profit and Loss account. Trade discounts are not recorded in the financial statement.