What are Purchase Returns and Allowances?

This line item is the aggregation of two general ledger accounts, which are the sales returns account and the sales allowances account. Both of these accounts are contra accounts, which means that they offset gross sales. The natural balance in these accounts is a debit, which is the reverse of the natural credit balance in the gross sales account.

• Because of all the new income statement-related accounts that were introduced for the merchandising concern, it is helpful to revisit the closing process.
• A quick stroll through most any retail store will reveal a substantial investment in inventory.
• When a purchaser receives defective, damaged, or otherwise undesirable merchandise, the purchaser prepares a debit memorandum that identifies the items in question and the cost of those items.
• The purchase returns and allowances accounts exist due to the accruals concept in accounting.

The perpetual system is what we will be doing in the next unit as we study the perpetual system. When merchandise is returned to suppliers or a price adjustment (allowance) is requested, the buyer usually contacts the supplier in writing. This written information is called a debit memorandum or debit memo.

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However, it affects the company’s purchases figure in its income statement. Usually, companies record purchase allowances in the same account as purchase allowances. Under the perpetual inventory method, we compare the physical inventory count value to the unadjusted trial balance amount for inventory.

In our example for Hanlon, May 4 was FOB Destination and we will not have to do anything for shipping. On May 21, shipping terms were FOB Shipping Point meaning we, as the buyer, must pay for shipping. Under the periodic inventory system, we will debit Transportation (or freight) In for the shipping cost and credit cash or accounts payable depending on if we paid it now or later. The perpetual inventory method has ONE additional adjusting entry at the end of the period. This entry compares the physical count of inventory to the inventory balance on the unadjusted trial balance and adjusts for any difference.

Accounting Treatment

Goods available for sale is the sum of beginning inventory and net purchases. Goods available for sale is not an account, per se; it is merely a defined result from adding two amounts together. The total cost incurred (i.e., cost of goods available for sale) must be “allocated” according to its nature at the end of the year. The cost of goods still held are assigned to inventory (an asset), and the remainder is attributed to cost of goods sold (an expense). A quick stroll through most any retail store will reveal a substantial investment in inventory.

Format of Purchase Returns and Allowances Journal

When a buyer receives a reduction in the price of goods shipped but does not return the merchandise, a purchase allowance results. Purchase returns and allowances are an important aspect of business as they can significantly affect profitability and cash flow. They can also provide valuable feedback to sellers about problems with their goods or shipping processes, allowing them to make improvements and reduce future returns and allowances. In both cases, these transactions reduce the amount that the buyer owes to the seller. In accounting terms, they are usually recorded as a reduction in the buyer’s Inventory account and Accounts Payable account, assuming that the original purchase was made on credit.

Sales returns for when a customer used store credit

If there is a difference (there almost always is for a variety of reasons including theft, damage, waste, or error), an adjusting entry must be made. If the physical inventory is less than the unadjusted trial balance inventory amount, we call this an inventory shortage. Companies using periodic inventory don’t update the Merchandise Inventory account when purchases or sales are made.

The https://personal-accounting.org/purchases-returns-and-allowances/ account is offset against total purchases when calculating the cost of goods sold. To illustrate the periodic inventory method journal entries, assume that Hanlon Food Store made two purchases of merchandise from Smith Company. In some cases, companies might not include sales returns and allowances as a separate account. Instead, they record sales returns and allowances by directly debiting their sales accounts before crediting their accounts receivable or cash account. A purchase returns and allowances account is simply a virtual account that exists solely to show the net effect of all transactions relating to returns and allowances. The refunds and other allowances given by suppliers on merchandise originally purchased for resale are known as purchase returns and allowances.

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When companies incur an expense, this concept requires them to record it. It does not need a cash settlement to become eligible for recording. Since companies already record the purchase expense, they cannot reduce it unless due to an error. Therefore, they need the purchase returns and allowances accounts to offset it.

Cash and Merchandise Inventory accounts are current assets with normal debit balances (debit to increase and credit to decrease). Accounts payable is a current liability with a normal credit balance (credit to increase and debit to decrease). Whenever we are the buyer, use a combination of these 3 accounts only. Also, we are going to make some adjustments in the next section for returns, allowances, and discounts; but first, let’s check in on recording purchases. Notice that we did not post the purchases to the inventory account, which is a major difference between this periodic system and the perpetual system.