In normal course of business when customers receive damaged, defective, low quality or otherwise undesirable goods, they may return them to the seller or may have the option to retain them at a reduced price. Sales returns occur when a customer does not accept such goods and return them to the seller for a full refund or credit and sales allowance occurs when a customer chooses to accept them but at a reduced price. In a company’s general ledger, both sales returns and the sales allowances are recorded in a single account known as sales returns and allowances account.
The journal entry for sales returns and allowances
When a customer returns the goods or an allowance is allowed to him, the seller prepares a credit memorandum (abbreviated as credit memo) which contains information about type, quality, quantity, price and invoice number of the goods being returned by the buyer. The original copy of the credit memo is sent to the buyer to intimate him that the return or allowance has been approved and his account has been credited. A duplicate copy of the memo is kept by the seller which acts as a source document for recording journal entry relating to sales returns and allowances. A sales memo is also often referred to as “credit note”.
There are two approaches for making journal entries of transactions involving sales returns and allowances. A company may choose any approach depending on its volume of sales returns and allowances during the year. The first approach is to record sales returns and allowances in general journal and is appropriate for companies that have a few sales returns and allowances during the year. The second one is to recorded these transactions in a special journal known as sales returns and allowances journal and is convenient for companies that experience many sales returns and allowances during the year.
Format of sales returns and allowances journal
The number of columns used in sales returns and allowances journal usually differ from one organization to another depending on their information requirements and nature and size of business. However, the following format can be used for a common understanding of recording transactions relating to sales returns and allowances:
Explanation of the columns
- Date: The date at which the goods are returned by the customer.
- Credit memo number: All credit memos are serially numbered. This column is used to record number of credit memo.
- Customer’s account credited: When a customer purchases the goods on credit, his account is debited; and when he returns the goods, his account is credited. This column is used to write the title of the customer’s account who returns the goods.
- Posting reference (PR): Mostly all accounts in the ledger are properly numbered. This column is used to enter the number of the relevant account in the ledger. If a manual accounting system is used and the accounts are not numbered then page number of the ledger book on which the account exists is used as account number.
- Accounts receivable-Cr: The amount by which a customer’s account is credited is entered in this column. This amount includes original sales price plus any sales tax imposed by tax agencies. The individual amounts in this column are immediately (or daily) posted to the relevant accounts in the accounts receivable subsidiary ledger. At the end of some appropriate period (usually one month), the total of this column is credited to accounts receivable account in the ledger.
- Sales tax-Dr: When goods are returned by customers, the related sales tax is debited. The amount of sales tax related to sales returns is written in this column. At the end of some appropriate period (usually one month), the total of this column is debited to sales tax payable account in the general ledger.
- Sales returns and allowances-Dr: In this column, the sales price of goods returned (excluding sales tax) or allowance allowed to customers is written. The sales returns and allowances account in the general ledger is debited by the total of this column at the end of some appropriate period (usually one month).
- Inventory-Dr/ cost of goods sold-Cr: When a customer returns goods, it increases inventory and decreases cost of goods sold. The cost of inventory that is returned by the customer is written in this column. The inventory account is debited and cost of goods sold account is credited by the total of this column at the end of the period.
The following example summarizes the whole explanation given above.
The Marya Trading Company always sells goods to it customers on account. The company collects sales tax @ 7% on all goods sold by it and periodically sends the collected amount of tax to a tax collecting agency.
The following are some selected transactions performed by Marya Trading Company during the month of January, 2018.
- Jan. 21: Sold goods to James Walker on account, $300. Sales tax was collected @ 7%.
- Jan. 22: Sold goods to Ed Ramirez on account, $100. Sales tax was collected @ 7%.
- Jan. 23: The goods sold to Ed Ramirez on January 22 were returned by them.
- Jan. 25: The goods sold to James Walker on January 21 were returned by them.
- Jan. 26: Sold goods to Robert Co., $500. Sales tax was collected @ 7%.
- Jan. 28: The goods sold to Robert Co. on January 26 were returned by them.
The ledger account balances on January 1, 2018 were as follows:
General ledger accounts:
- Accounts receivable account: 3,500 Dr.
- Inventory account: 12,500 Dr.
- Sales tax payable account: 1,050 Cr.
Accounts receivable subsidiary ledger accounts:
- James Walker: 200 Dr.
- Ed Ramirez: 0
- Robert Co: 350 Dr.
- Record the transactions occurred on January 22, 25 and 28 in a sales returns and allowances journal.
- How would you post the information from sales returns and allowances journal to accounts receivable subsidiary ledger and general ledger?
(1). Recording entries in sales returns and allowances journal:
(2). Posting entries from sales returns and allowances journal to ledger accounts: