2.1. Merchandise returned for cash refund

In the case of a cash refund, the store will make the following journal entry:

Note: The selling price of the returned cups before the discount is $10 = $5 x 2 cups. The discount amount related to the two cups is $2.50 = $10 x 25%. The sales tax for the returned cups is $0.60 = ($10 - $2.50) x 8%.

The store’s accountant debits (i.e., increases) the Sales Returns and Allowances account when recording the return of the cups. The increase in this account will result in a decrease in Net Sales because Sales Returns and Allowances are subtracted from Gross Sales to arrive at Net Sales. In other words, the increase in the sales returns results in the decrease in the net sales. As the Sales account has a credit balance, the Sales Returns and Allowances account, a contra-revenue account, has a debit balance.

Furthermore, Pottery Wiz’s accountant has to debit (i.e., decrease) the Sales Taxes Collected account in order to decrease this liability account. (The Sales Taxes Collected account represents a liability to the government, and as the taxes for the cups returned are no longer due, the store has to debit the Sales Taxes Collected account.)

To reverse the sales discount, the store’s accountant has to credit (i.e., decrease) the Sales Discount account. Note that the Sales Discount account normally has a debit balance because it’s a contra-revenue account.

Finally, to show the return of money to Jane Smith, Pottery Wiz’s accountant credits the Cash account.

At the time of the cash refund, the store gives Jane Smith the following credit slip:

Pottery Wiz’s accountant also has to record the returned inventory cost and decrease the cost of goods sold:

The $3.00 is based on the cost of one cup and two cups returned: $3.00 = $1.50 x 2 cups.

2.2. Merchandise returned for store credit

Accounting for a return of merchandise for a store credit is almost the same as in the case of a cash refund. The only difference is that instead of crediting Cash the store’s accountant should credit Accounts Payable to recognize the liability to the customer. When the customer buys some merchandise in the future using the store credit, Pottery Wiz’s accountant will debit the Accounts Payable account.

To record the store credit, Pottery Wiz’s accountant would make the following journal entry:

The store’s accountant would also have to decrease the cost of goods sold and record the cost of inventory returned (see the previous section).

At the time the store credit is issued to Jane Smith, the store would give the following credit slip to her:

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