Published in: Accounting

Is sales return debit or credit?

Author Obotu Agape Oguche

Published on: October 21, 2022

Is sales return debit or credit? Customers usually return defective and damaged products to retailers. These retailers then have to account for these returned products in their financial records. Hence, they record them in the sales returns and allowance account. This sales return and allowance account is the balance from the difference between gross sales and net sales.

Companies report sales return and allowance separately from sales for two main reasons. First, this account has a negative impact on profitability, and secondly, management may use the information in the account to analyze return trends by product category, retail location, and other factors. Because when there are higher-than-average returns in a company, it might be an indication that the company has quality issues and other operational issues that the management has to address.

Sales return is, therefore, recorded when a customer returns the products purchased by them and receives a refund for the purchase price. This account reduces the revenue generated from the sales and as such is a contra-revenue account that offsets the balance of revenue. Hence, sales return and allowance is listed as a line item in the income statement which is presented as a subtraction from the gross sales line item. It reduces sales by the amount of product returns from customers and sales allowances granted.

It is important to know that sales returns and allowances are actually two different transactions, though, they are recorded in the same account. This usually happens when the balances of these accounts are relatively small. Because when the balances are relatively small, there is usually no point in tracking sales returns and allowances separately. Having known that sales return and allowance is a contra account; is sales return debit or credit?

In this article, we will discuss sales return, debit and credit entries, and whether sales return is reported as a debit or a credit. First, let’s have an understanding of sales return in business.

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Understanding sales return

A sales return, which is also known as returns inwards, is a situation whereby a customer returns the products that they purchased and receives a refund (the purchase price) from the seller. This normally happens for several reasons such as a change of mind by the customer (deciding not to like the product), the wrong size of the product, product defects, the product being below the customer’s expectations, the product arriving damaged, etc.

Whatever the case may be, as customers return these purchased goods, they intend to receive a refund. In such cases, it is expedient for businesses to keep track of these sales returns so that they can keep their accounting records up to date. This will help in eliminating any errors in the financial statements and records. Therefore, when a customer returns a product that was purchased and receives a refund for the purchase price, the store has to record the return as a negative sale in the sales revenue account or record the return in the sales return account.

For example, Johnny Diary Co. sold 1,200 bottles of milk to Mr. Peter for $0.50 per bottle. Assume, Mr. Peter, later on, returned 6 boxes containing 300 bottles because they were expired. Apparently, Johnny Diary Co. sent some wrong boxes to Mr. Peter, so as Mr. Peter returns the 6 boxes, Johnny Diary Co. will give him a refund of $150 and update their accounting records. There are two ways that Johnny Diary Co. can record this.

One of the approaches would be to use the sales return account. Johnny Diary Co. can record the $150 (300 bottles x $0.50) in the sales return account. The company uses this account to track all sales returns and allowances, which are then deducted from sales revenue on the company’s income statement. This will help the company to accurately calculate its net sales.

The second way Johnny Diary Co. can handle this sales return is to record the $150 as a negative sale. This means that the company will record the $150 sales return as a negative number directly into the sales revenue account.

Nevertheless, using the sales return account has proven to be very useful. This is because it helps the business track returns and allowances. This is essential because it can help them identify problem products. For instance, a product with a high return or allowance rate could be an indicator that something is wrong with the product. It could be that the product is below the customer’s expectation or it could be that the product is defective. Whatever the case might be, it is important for businesses to be aware of this so that they can work towards fixing the problem.

Conclusively, sales return in business is a normal phenomenon because it is expected that there will be some sales return in the future due to the limited availability or imperfections of certain products. Hence, sales returns should not cause too much concern for companies. However, if there is a significantly increased amount of sales returns each month, companies should identify the reason behind it and try to fix it. This is because if the sales returns and allowances account is continuously increasing, it may mean that something is wrong with the company’s goods and services.

The sales return account

In the company’s financial statements, the sales return account is treated as a contra account. It is a contra-revenue account with a debit balance that reduces the credit balance of the gross sales revenue on the company’s income statement. Sales returns and allowances as well as sales discounts are all contra-revenue accounts which are also known as contra-sales accounts. They are contra-sales accounts because they offset sales revenue in order to report the net sales that are generated by a business for an accounting period. This means that sales returns and allowances are deducted from sales or gross sales in the income statement.

Contra sales accounts are presented separately from the gross sales revenue on an income statement to show the sales return, allowance and discounts that reduced the original total value of the sale to the net amount. This will give a user of the financial statement more information compared to when only the net balance is reported. That is, the reader of the income statement will be able to differentiate between the original amount of sales revenue generated, the sales reduction, and the resulting net amount.

When recording sales, it is usually advisable to use a revenue account and a contra-revenue (contra-sales) account. The revenue account will report the value of the original sale while the contra-sales account will report the details of any sales returns, allowances, and discounts, that reduce the value of the original sale. Therefore, the contra-sales account allows the company to see the original amount of product sold and also see the items that reduced the sales to the net sales amount.

A contra-revenue account as a contra account is expected to have a balance that is the opposite of or contrary to the usual credit balance in a revenue account. This means that the contra-revenue accounts which are sales returns and allowances as well as sales discounts are expected to have a debit balance rather than the usual credit balance of the sales or revenue account. The table below shows the sales revenue accounts as well as its contra accounts and their natural balance:

As shown above, the sales return which has been highlighted in the table will increase by a debit entry and decrease by a credit entry. What does this mean? Let’s look at what debit and credit mean to have a proper understanding of this.

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Debit and credit in T-account

When it comes to recording transactions in business, the numbers are recorded in the debit and credit columns. These entries are used within a business’s chart of accounts to record every transaction. Debits and credits are very essential for the correct balancing of a business’s financial accounts. They are frequently used by accountants and bookkeepers when recording transactions. When a customer returns purchased goods back to the company, a transaction occurs that needs to be recorded. First, the sales return has to be recorded and secondly, the refund given to the customer has to be recorded as well.

Now, when such a transaction occurs, an amount must be entered on the right side of the balance sheet as a credit entry and the same account has to be entered on the left side of the balance sheet as a debit entry. This accounting system is known as a double-entry system also called T-account which helps to provide accuracy in financial records. In the T-account, the debits are positioned on the left-hand side and the credits are positioned on the right-hand side of the ledger. Accountants make use of debits and credits to record every business transaction and use the balancing T-account system to generate financial statements.

For instance, recall our initial example of sales return, where Johnny Diary Co. sold 1,200 bottles of milk to Mr. Peter for $0.50 per bottle, but Mr. Peter, later on, returned 6 boxes that contained 300 bottles because they were expired. As Mr. Peter returned the 6 boxes, Johnny Diary Co. gave him a refund of $150 and had to update their accounting records. To record this sales return, two accounts will be affected by a debit or credit entry. Johnny Diary Co. will have to record the $150 as a debit to the Sales return and allowance account and record the same $150 as a credit to the Cash account. This will therefore balance the transaction.

In T-accounts, the debit and credit entries record changes in value resulting from business transactions. Hence, a debit entry in an account would basically mean a transfer of value to that account, while a credit entry would mean a transfer of value from the account. That is, a credit entry will always add a negative number to the journal while a debit entry will add a positive number.

A debit entry will increase asset or expense accounts while reducing revenue, equity, or liability accounts. A credit entry, on the other hand, will increase revenue, equity, or liability accounts while decreasing asset or expense accounts. Revenue, for instance, is the total amount of income realized from the sale of goods and services which is responsible for an increase in equity. Hence, the normal balance for revenue would be a credit balance which is increased by a credit entry and decreased by a debit entry.

However, this would not be the case for contra-revenue accounts like Sales Returns, Sales Allowances, and Sales Discounts. Contra accounts are used in a general ledger to reduce the value of the related account when the two are netted together. Therefore, the natural balance of a contra account would always be contrary to the associated account. Since Sales Returns, Sales Allowances, and Sales Discounts are reductions to sales, their balance would be the opposite of the normal credit balance of revenue/sales. This means that sales return as a contra-sales account would have a debit balance which is the opposite of the natural credit balance for sale.

Let’s discuss this further.

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Sales return as a contra revenue account is a debit entry in the books of accounts. A revenue account increases with credit and decreases with a debit. When a company makes a sale, the sales revenue account is credited to the books of account as it leads to an increase in revenue. However, when the customers return the goods, the return causes a debit effect because it leads to a decrease in revenue. Therefore, according to the modern rule of accounting the sales return account has to be debited because it causes a decrease in the revenue of the business. (Luca Pacioli is the father of modern accounting).

In a situation whereby the sales were made on a credit basis, the expected accounts receivable would be credited by the returned purchased amount as no amount will be received. However, in a situation whereby the sales were made on a cash basis, the accounts payable or cash account should be credited to acknowledge the liability of repaying the customer for the purchase.

Journal entries examples showing sales return as a debit and not a credit

In order to record a sales return transaction, you have to debit sales returns and allowances by the selling price and debit the appropriate tax liability account if any, by the taxes collected on the original sale. Then, credit the cash or accounts receivable account by the full amount of the original sales transaction. Let’s look at some examples:

Example 1

A customer returns a $100 item and the applicable sales tax rate is 7 percent. This is how the journal entry for this transaction would look like:

As shown in the journal entry above, the Sales returns and allowances account is debited by $100, as well as a debit to sales tax liability by $7 (0.07 x $100) and a credit entry to the cash account by $107 ($100 + $7). This journal entry accounts for the tax liability and ensures that the customer receives the full return. It essentially balances the transaction and brings the books back to zero against the entire transaction.

Example 2

A customer bought 4 products from Company XYZ on credit which is worth $12,000 and returned one of them which is worth $3,500. The store had to refund $3,500 to the customer for the returned product and update their records to show a sales return of $3,500. Depending on the accounting system being used, this can be directly deducted from sales revenue or can be recorded in the sales return account. If recorded in the sales return account, the journal entry for this will be:

As shown above, this journal entry involves recording a debit of $3,500 in the sales returns and allowances as well as recording a credit in an accounts receivable account. If the product that was returned was not defective, it can be resold. Hence, it will be returned to the inventory account. Therefore, a journal entry will also need to be made to account for the goods returning to inventory and the cost of goods sold. This would involve recording a debit in the inventory account as well as recording a credit in the cost of goods sold (COGS) account.

However, if the customer didn’t buy the goods on credit and paid cash, the sales return would be recorded against a sale on cash, and the journal entry will look like this:

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Is sales return debit or credit in trial balance

Sales return is treated as a contra-revenue transaction, so, the amount of sales return is deducted from the total sales of the company. It holds a debit balance and is therefore placed on the debit side of the trial balance. In order to understand this better let’s look at an example with a trial balance (tabular format).

Assume, on 1st September, ABC Ltd. (a dealer in refrigerators) sold 20 refrigerators for $500,000 on credit to XYZ Ltd. Say, on 25th September, XYZ Ltd returned all the refrigerators to ABC Ltd. due to the serious defects in the model of the refrigerators. This would be the journal entry for the above transaction in the books of ABC Ltd:

The placement of this sales return in the Trial Balance would then look like this:

TRIAL BALANCE

See also: Cost of sales debit or credit?

Conclusion

Conclusively, the sales returns account is classified as a contra-revenue account because it causes a deduction from the gross sales which correspondingly, results in a decrease in the net sales figure. Therefore, sales return is a debit and not a credit.

In a case of return whereby, the sale was made on credit, the seller will record the sales return by debiting a Sales Return and Allowances account and crediting the Accounts Receivable account. This credit entry to the accounts receivable account will reduce the outstanding amount of accounts receivable.

Conversely, in the case of a sales return whereby, the sale was made against cash, the seller will record the sales return by debiting the Sales Return and Allowances account and crediting the Cash or Payable to the customer account.

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