The process of recording closing entries for service companies was illustrated in Chapter 3. If you have accounting software or a bookkeeper, you may not be making these entries yourself. But knowing how entries for sales transactions work helps you make sense of your general journal and understand how cash flows in and out of your business. How you handle purchase returns depends on your small business return policy.

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To illustrate, suppose that Lakeside Electronics issued the credit memorandum shown in the figure below to Champ’s TV Sales for the return of a defective 19-inch TV. Return of merchandise sold for cash is entered in the cash payments journal or cash book. So once this entry is posted, inventory will be increased, and the cost of goods sold will be derecognized.

• This account has a negative or debit balance, so it is also called a contra-revenue account.
• When a company sells a product or service to a customer, it will use the journal entries below.
• Discounts allowed represent a debit or expense, while discount received are registered as a credit or income.
• Similarly, the credit side for the entries will depend on how companies compensate their customers.
• Sales revenue is increasing in credit and decreasing in debit accounts.

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These types of entries also show a record of an item leaving your inventory by moving your costs from the inventory account to the cost of goods sold account. When only “Net Sales” is presented in the income statement, its computation is shown in notes to financial statements. When the above entry was posted to the accounts receivable ledger, a small checkmark was made to the right of the diagonal line. This entry is made when a customer notifies the business that they will return the merchandise. An allowance is a price reduction on an item, often because of a sale or a flawed item like a floor display model with a dent. On 1 July 2014, it sold 500 footballs each to Club A and Club B at a price of $20 per football.

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Once ordered, companies may deliver the goods or request customers to get those goods from a warehouse. Accounting for sales return is mainly concerned with revising revenue and cost of goods sold previously recorded. Account receivable or cash and cash equivalents should also affect whether it is the cash sale or credit sales.

How to Manage Accounts Receivable for Services Industry Company?

You can set-up a sales returns and allowances account by opening an appropriate account in your chart of accounts. You can then create journal entries from the beginning that will automatically debit this new account on all future transactions. The discount allowed journal entry will be treated as an expense, and it’s not accounted for as a deduction from total sales revenue.

Once sales are made, not only sale revenue and account receivable are affected by this transaction. The goods will deliver to the customer, and the inventories will reduce. On 1 February 2016, John Enterprise sold merchandise for $1,500 to Sam Enterprise on account. On the same date, merchandise amounting to $200 were returned to John Enterprise because they failed to meet the required quality standards. These merchandise were returned to the Modern Trading Company on the same day. In turn, the Modern Trading Company granted a cash refund of $500 to Small Retailers on 2 January 2016.

It is one of the similarities between sales returns and allowances. However, companies offer sales allowances before the customer pays for them. Instead, they keep those goods while also receiving a reduction in price for them. Like sales returns, companies have to record sales allowances separately.

Because if you sell products at your business, you know that not all customers are satisfied. If a customer wants to bring back an item, you need to make sales returns and allowances journal entries. Companies use various tactics to increase their sales and revenues. As mentioned, buyer entries under perpetual method financial accounting some companies offer credit sales which can increase these numbers. Some others may also provide customers with various allowances or offer them sales returns. Before understanding how to record sales returns and allowances, it is crucial to define what these are.