How to account for customer returns

May 30, 2011

Explanation of accounting for customer returns, sales and return allowances, purchase allowances, cash refunds and store credits.

1. Accounting for sale or purchase of damaged goods

Many businesses, whether a large chain store or a small “mom-and-pop” shop, have to deal with returns of merchandise because sold items may be broken or damaged. It is important to understand accounting for purchases and sales of damaged goods not only to make appropriate journal entries but also to design a good internal control system over returned merchandise and related accounts (e.g., Cash, Accounts Payable).

Please note that we are not going to cover the question of establishing reserves for customer returns in this article. Such reserves may need to be established to adhere to the generally accepted accounting principles and in particular, the matching principle.

2. Journal entries for damaged goods returned by customers

There are two common approaches to refunding customers for returned goods:

  • a cash refund
  • a store credit

Let us look at each one using the following example:

On May 1, 20X1, Jane Smith purchased, with a debit card, some pottery on sale at a local store called Pottery Wiz. She bought 10 cups ($5 each) and 10 plates ($8 each) for a total of $130, less 25% sales discount, and paid 8% sales tax. She received the following receipt from the store:

Sales Slip

To record the sale, Pottery Wiz made the following journal entry:

Account Titles

Debit

Credit

Cash

105.30

 

Sales Discount

32.50

 

      Sales Taxes Collected

 

7.80

      Sales

 

130.00

Assuming the store bought the cups and plates for $1.50 and $3.00 each, respectively, at the time of sale to Jane Smith Pottery Wiz recorded the cost of goods sold in the amount of $45.00 (i.e., 10 x $1.50 + 10 x $3.00 = $15.00 + 30.00 = $45.00):

Account Titles

Debit

Credit

Cost of Goods Sold

45.00

 

      Merchandise Inventory

 

45.00

To continue the example, let us assume that on May 2, 20X1 Jane Smith came back to the store to return two (2) cups as they were damaged (e.g., paint defects). Pottery Wiz can either refund cash or issue a store credit, depending on its return policy.

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