Sales Returns and Allowances Journal Entry

When a business sells products or goods, there is the possibility of a return by its customers due to faulty or obsolescence within the agreed timeframe. The accounting for sales return and allowances is straightforward and the difference between a perpetual inventory system and a periodic inventory system.

In this article, we cover the accounting for sales returns and allowances; especially the sales returns and allowances journal entry under both periodic and perpetual inventory systems.

So now let’s get started!

What is Sales Return and Allowances?

Sales return and allowances refer to the sales adjustment as a result of the return of goods or merchandise inventory or a reduction from the original selling price due to damages or defective goods or products. Sales return and allowances are the contra account of the sales revenue account. It represents the adjustment to arrive at the net sales.

Sales return and allowances is an item revenue presented as a reduction of sales revenue in the income statement. As mentioned above, it is a contra account of sales revenue account; therefore, sales return and allowances are recorded on the debit side.

Classification and Presentation in the Income Statement

As mentioned above, sales return and allowances is a contra account of sales revenue account. To arrive at net sales, we take the gross sales or simply sales revenue minus sales discount as well as sales return and allowances. In a single-step income statement, we do not present the sales return and allowances separately. It is presented as a net basis under net sales revenue.

However, in a multiple-step income statement, the sales return and allowances are presented separately as per the extract below:

READ:  5 Criteria Test to Distinguish Operating Lease vs Finance Lease under GAAP Rules
Sales XXX
Less: Sales discountXXX 
          Sales return and allowancesXXXXXX
Net sales XXX

Sales Returns and Allowances Journal Entry

Accounting for sales returns and allowances is simple. Depending on the inventory system the company adopts; either perpetual or periodic inventory system, the journal entry for the sales returns and allowance is the same except the additional entry on the cost of goods sold and merchandise inventory in the perpetual inventory system.

In the section below, we illustrate how the sales return and allowances are recorded in both perpetual and periodic inventory systems.

Sales Returns and Allowances Journal Entry under the Periodic Inventory System

Under the periodic inventory system, there is only one journal entry to record the sales return and allowances. The cost of goods sold and a reduction in merchandise inventory is not recorded.

Below is the journal entry to record sales return and allowances under the periodic inventory system:

Account NameDebitCredit
Sales return and allowancesXXX 
Accounts receivable XXX
(To record the sales return and allowances from the customer)  

Sales Returns and Allowances Journal Entry under the Perpetual Inventory System

Under the perpetual inventory system, there is an additional entry to include the cost of goods sold and its correspondence entry of merchandise inventory. This is because the sales return and allowances result in a reduction in the cost of goods sold and an increase in merchandise inventory.

Below is the sales returns and allowances journal entry under the perpetual inventory system:

READ:  Six Common Performance Measures for Inventory Management
Account NameDebitCredit
Sales return and allowancesXXX 
Accounts receivable XXX
Merchandise inventoryXXX 
Cost of goods sold XXX
(To record the sales return and allowances from the customer)  

Example

In order to clearly understand the accounting for sales returns and allowances, let’s go through the example below.

Let’s assume that ABC Co sells goods to its customer on 05 January 20X1 for $2,500. In the sales agreement, ABC Co would accept the sales return if the goods are damaged or defective. The customer receives goods on the same day. On 07 January 20X1, the customer finds out that some of the goods received are defective. Therefore, the customer returns such goods back to ABC Co with a value of $500. The cost of these returned goods is $400.

From the example above, we illustrate the journal entry for the sales as well as sales return and allowances under both periodic and perpetual inventory systems as follow:

Journal Entry under Periodic Inventory System

The journal entry to record the sales of goods on 05 January 20X1 is as follow:

Account NameDebitCredit
Sales$2,500 
Accounts receivable $2,500
(To record the sales revenue on credit to the customer)  

The journal entry for the sales returns and allowances on 07 January 20X1 is as follow:

Account NameDebitCredit
Sales return and allowances$500 
Accounts receivable $500
(To record the sales return and allowances from the customer)  

Journal Entry under Perpetual Inventory System

As mentioned above, under the perpetual inventory system, there is an additional entry to record the reduction of cost of goods sold and the increase in merchandise inventory.

READ:  Drawing Vs Dividends: Is Owner’s Drawing the Same as Dividends?

The original sales journal entry is the same as the periodic inventory system. Thus, you can refer to the journal entry in the above section.

However, below is the journal entry for the sales returns and allowances under the perpetual inventory system:

Account NameDebitCredit
Sales return and allowances$500 
Accounts receivable $500
Merchandise inventory$400 
Cost of goods sold $400
(To record the sales return and allowances from customer)  

As you can see, under the perpetual inventory system the cost of goods sold reduced by $400 while the merchandise inventory increased by the same amount as the return of the goods inward.

Conclusion

The accounting for sales returns and allowances is very straightforward. The sales return and allowances account under the periodic inventory system is recorded the same way as under the perpetual inventory system. However, the only difference is the additional entry to reduce the cost of goods sold with the correspondence increase of merchandise inventory under the perpetual inventory system.

Scroll to Top