How to account for customer returns

3. Journal entries for returns of damaged goods to supplier

Let us assume Pottery Wiz purchased the damaged (e.g., with paint defects) cups, returned by Jane Smith, from Pottery Wholesaler on April 25, 20X1.

On May 1, 20X1 Pottery Wiz received and recorded an invoice for these and other cups but has not paid it yet. If the store is able to return the damaged merchandise to Pottery Wholesaler for a refund or credit allowance, at the time of the return to Pottery Wholesaler, the following journal entry is made:

Account Titles



Accounts Payable



      Purchase Returns and Allowances



By debiting the Accounts Payable account the store reverses (i.e., decreases) its liability to Pottery Wholesaler.

If Pottery Wiz had settled the liability to Pottery Wholesaler with cash before returning the damaged cups, the store’s accountant would debit the Cash account (instead of the Accounts Payable account) when cash reimbursement for the damaged cups is received from Pottery Wholesaler.

If the retail store paid cash and took a purchase discount when originally paying to Pottery Wholesaler, the store’s accountant would only post a debit for the net amount because only the net amount (i.e., total purchase price – purchase discount) would be refunded. For instance, if a 2% discount has been taken when the cups were purchased, Pottery Wiz’s accountant would debit Cash for $2.94 (i.e., $3.00 x 98%), debit Purchase Discounts for $0.06 (i.e., $3.00 x 2%), and credit Purchase Returns and Allowances (or Merchandise Inventory) for $3.00.

Note that Pottery Wiz’s accountant can either credit Merchandise Inventory or Purchase Returns and Allowances. However, unless a business has a small amount of inventory, it is preferred to use the Purchase Returns and Allowances account to track and control the costs incurred in returning merchandise or negotiating purchase allowances. Note also that purchase returns refer to the return of goods by a buyer to a seller. Purchase allowances refer to the reduction in the price of goods shipped by a supplier.

Pottery Wiz can initiate the return of damaged goods and request a reduction of the balance due to Pottery Wholesaler by issuing a debit memorandum. The debit memorandum will inform the supplier that the purchaser (i.e., Pottery Wiz) has debited the supplier’s account on its (i.e., purchaser’s) books. Pottery Wiz will send the original debit memorandum to Pottery Wholesaler and keep a copy for its records. An example of a debit memorandum is shown below:

Debit memo 

The store can record the reduction in the Accounts Payable account when it sends the debit memorandum, or it can wait for a credit memorandum from its supplier.

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