Do you sell products at your small business? If so, you know that not all customers are satisfied with their purchases. If a customer wants to bring back an item, you need to know how to record a purchase return in your books.
What is a purchase return?
No matter how great your products are, not every customer is going to be satisfied. Sometimes, customers bring goods back to your business. This is called a purchase return.
A customer might return a good for several reasons:
- They bought more than they needed.
- They didn’t buy the right product.
- You sent the wrong good.
- The good is damaged.
As a small business owner, you decide how to handle purchase returns in your small business return policy. You might offer free returns, charge a restocking fee, or not accept returns. You can also compensate the customer for the return with store credit or a cash payment. In most cases, the customer receives a refund when they physically return the good. And, you can set a time period in your payment terms and conditions about when customers can receive a refund for returns.
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. You reverse the accounts by using debits and credits.
Purchase returns and allowances: debit or credit?
With double-entry bookkeeping, you make two entries for every transaction. Each entry is either a debit or credit. Debits and credits are equal and opposite. A combination of debits and credits balances your accounts.
Some accounts are increased by debits while others are increased by credits. If an account is increased by a debit, it is also decreased by a credit. And if an account is increased by a credit, it is also decreased by a debit. The following chart shows how each account is affected by credits and debits.
Accounts used for a purchase return
When recording a journal entry for returns, you debit and credit different accounts to reverse the sale. Before you start, you might want to get familiar with the accounts used.
Sales returns and allowances
What type of account is sales returns and allowances? The sales returns and allowances account represents returned goods at your business. This account is a contra revenue account, meaning it opposes the revenue account. A sales returns and allowances journal entry in this account shows a decrease in revenue.
Cash and accounts receivable
Depending on the payment method used, you will enter in your cash account or accounts receivable. With a return made on a cash purchase, the cash account decreases.
If a customer bought on credit, you consider the sale a part of accounts receivable. Accounts receivable includes money owed to you by customers. With a return for a sale made on credit (i.e., you invoiced the customer), your accounts receivable decreases.
Accounts payable includes money you owe to others. For example, you record a payable when you receive a bill from a supplier. Accounts payable is a liability. Entries in the accounts payable account are called payables. If you give store credit for returns, your accounts payable will increase.
Cost of goods sold
The cost of goods sold includes all the expenses that go directly into your products. Raw materials and direct labor are examples of the cost of goods sold.
The cost of goods sold is a business expense. There is no contra account (like sales returns and allowances) when recording a return. Instead, the amount of cost of goods sold simply decreases.
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Recording a purchase return
Accounting for sales returns can be tricky. But, don’t be overwhelmed by debits and credits. 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.
The method of payment on the original purchase matters when recording a return. How you will compensate the customer is also important.
First, answer the following questions:
- How was the original purchase made?
- What will you give the customer in exchange for the return?
Then, follow our simple steps to record a sales return journal entry.
Purchase returns for when a customer paid cash
The way you record a return from a cash-paying customer differs depending on how you plan to refund them. You can refund a customer with cash or store credit. Follow the appropriate directions below to record a return for a cash sale.
You might give the customer back the money they used to pay for your product. Use this method to record a return with a cash refund:
|Sales Returns and Allowances||X|
Here are some key points about recording a return with a cash refund:
- Debiting sales returns and allowances will increase the number of returns you have.
- Crediting cash will decrease your income.
The entries lower your net sales. The more returns you have, the more your income decreases.
Rather than refunding a customer with cash, you might credit merchandise at your business. Accounting for a purchase return with store credit is similar to a cash refund. Instead of entering in your cash account, you make an accounts payable entry.
Store credit is a payable. Payables are liabilities, or an amount you owe (in this case to the customer).
Use this method to record a return with store credit:
|Sales Returns and Allowances||X|
Here are some key points about recording a return when you credit merchandise:
- Debiting the sales returns and allowances will decrease your income.
- Crediting the accounts payable will increase your liabilities.
The entries increase your liabilities and decrease your net sales. The more returns you have, the more you owe to customers.
Purchase returns for when a customer used credit
If a customer does not pay cash at the point of sale, you probably extended credit. Recording a purchase return for a sale made on credit is a little different than when a customer pays cash.
If the purchase was made on credit, the original sale was recorded as a receivable. A receivable is money owed to your business. To record the return, you need to reverse the receivable.
Use this method to record a return for a purchase made on credit:
|Sales Returns and Allowances||X|
The entries show that as your returns increase, your assets decrease. While you don’t lose physical cash, you do lose the sale amount. Your net sales will decrease.
Purchase returns and inventory
When accounting for sales returns, you should also record the change in inventory. The customer brings a good back to your business, which increases your inventory.
Your inventory record will look like this:
|Cost of Goods Sold||X|
Here are some key points about recording inventory with a return:
- Debiting inventory increases assets.
- Crediting the cost of goods sold reduces the cost of goods sold.
The report shows you have more inventory after the return.
Returned goods at your small business
Returns are a normal part of running a business. But, a lot of sales returns can hurt your business’s bottom line. If you don’t know how to account for a return, you books will be inaccurate. Make sure you keep track of returns at your business for a clear picture of your financial health.
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