Sales Return Journal Entry

Sales Return in terms of payroll journal entry can be defined as the one which shall be used to account for the customer returns in the books of account or to account for when there is a return of goods sold by the customer due to defective goods sold, or misfit in requirement of the customer, etc.

The accounting equation shall stand true when revenue is reduced from the Owner’s equity, and Assets are reduced either in cash or accounts receivable. Further, when the inventory and cost of goods sold are adjusted, one is increased and the second one is decreased; all belong to the Owner's equity, and hence the balance sheet is tallied. Sales returns should be accounted for as there could be cases where the firm might be inflating sales and recording returns in the next accounting period.

The concept of sales return journal entry explains the process which is followed while recording the return of goods which are already sold, also called return inward in the books of accounts. In this process, the initial sales that was done by the business is reversed while accounting for it.

The journal entry passed for the same is given below and explained in details. However, the journal entry for sales returns will be done typically using the double entry system that is followed in accounting, so that there is consistency and clarity.

It is to be noted that since journal entry forms the basis of accounting for any transaction and is the basic foundation of all financial statements and financial reporting of a business, it should be done correctly and state every detail of the transaction. Such details of credit sales return journal entry are referred to in future for clarification, decision making and auditing.

Below is the necessary journal entry that shall be passed in the books of account for an accounting of sales return.

#1 - When goods are returned, and no receivables were outstanding.

#2 - When goods are returned, and receivables were outstanding.

Note

The first entry in the above tables reduces the sales by sales return, and the second entry increases the inventory and adjusts the cost of goods sold.

Below are the examples of Sales Return Journal Entry –

Example #1

XYZ is operating in retail goods, and when it sells its goods, it is mentioned in its invoice that goods can be returned within 30 days. It made sales for $50,000,000 in Aug 2019, and it sold 60% on a cash basis, and the rest was sold on a credit basis. The company had $31,000,000 in outstanding receivables and $2,500,000 in cash at the end of Aug 2019 balance sheet. The cost of goods sold was $40,000,000, and the Closing Inventory showed a balance of $22,000,000. 5% of the goods sold were returned due to defective products. Further, the company earns a 20% gross margin on sales.

Based on the above information, you must pass sales return journal entries and estimated balances that will stay in sales, receivables, cash, inventory, and cost of goods sold.

Solution

We will first compute the sales return amount, which is 5% of the sales of $50,000,000, which shall equal $2,500,000. We shall pass journal entry for sales returns assuming that a ratio of 60% was returned in cash and the rest on receivables. Therefore, cash accounts will be credited by 60% of $2,500,000 which shall be $1,500,000 and receivables accounts shall be credited by 40% (100 – 60) of $2,500,000 which shall be $1,000,000.

Further, the inventories shall be reduced by $2,500,000 less than the 20% margin, which would be $2,500,000 less than $500,000, that is $2,000,000 that would add to inventory and lower the cost of goods sold by the same.

Below Entries shall be posted

1. Sales Return Journal Entry

2. Adjustment to the Cost of Goods Sold

Example #2

Cycle and Bike Inc. sell Cycle and bike on a cash and credit basis, almost equal in ratio. Mr. Vivek, who has gone for internal audit in this company, draws out two random samples to validate whether the company is recording journal entries accurately. The balances reported should be fair and accurate.

• 1st Sample: Bike for $55,000 sold to John. John paid the entire amount in cash on 1st September, and due to a defect in the bike, he returned the bike to a company on 20th September. Entire remits due to him were paid back to him on the same day.
• 2nd Sample : 3 cycles were sold for $30,000 to Mickey; Mickey paid for one Cycle in cash on 4th September, and for the rest, the payments were outstanding. The Cycle had some scratches and hence was returned on 6th September, and the rest two were retained. Since he has an exceptional amount that was adjusted against the same, the balance would be received from him.

The Gross margin on bikes was 25%, and on the Cycle, they earned 30% on cost. Therefore, based on the above information, you must pass sales return entries.

Solution

Let's calculate first the sales return value and adjustment that has to be made to the cost of goods sold.

• 1st Sample: Sales for $55,000 will be adjusted for a 25% gross margin, which can be computed as 55,000 x 25 / 125, which shall equal $11,000, and the amount that will be added to inventory would be $55,000 – $11,000, which is $44,000.

The Journal Entries would be-

• 2nd Sample: Sales for $10,000 ($30,000/ 3) will be adjusted for a 30% gross margin, which can be computed as $10,000 x 30 / 130, which shall equal to 2,308, and the amount that will be added to inventory would be $10,000 – $2,308 which shall be $7,692.

The Journal Entries would be-

From the above examples of credit sales return journal entry we can clearly understand how the transaction related to return of goods are accounted for by the business in the books and the required journal entries that are passed to make the reversal of sales. This ensures that the entire process is recorded for future reference and transparency of information. This process of financial recording should be strictly followed so that there is accountability and proper information, which can be used during audit and preparation of financial statements.

Incorrect recording of estimated sales return journal entry will have a lot of negative implications, like incorrect information regarding the inventory, mismanagement and funds and inflated revenue figures, because the good once sold out has again been added back to the inventory and revenue earned in the past from sales has been reversed.

A credit memo is a document that is prepared when a business owes money to their client. This may happen during a good return too, when the business has sold goods to the client but the client later informs the business that the goods are not up to their expectations and wants to return them. In such a case, since the client has already paid the business, they will want their money back upto a certain amount, as per the terms of the sales order.

Such a case may arise if the goods do not meet the client’s expectations, goods are damaged or the order is incomplete. In these cases the required sales return journal entry is passed under the category of good return or sales return. The entry will be as follows:

Sales Return A/c debit

To Accounts Receivable A/c

This document or credit memo informs the business that they need to return the sales amount to the client and make estimated sales return journal entry and arrive at the correct sales figure.

• Many companies sell goods on either a cash basis or credit basis. Hence, the ratio they maintained should be checked, and accordingly, the entry should be passed if the customer's details are unknown.
• By debiting the Sales account, the revenue of the firm is reduced, which shall impact the gross margin of the company as well.
• The cost of goods sold is also adjusted as the inventory increases the sales return. The gross margin should be noted whether it is on cost or sales. If it is on sales, then one can directly reduce sales amount by that margin, but if it’s on cost, one needs to adjust for weight.
• The cost of goods sold and inventory is adjusted for margin because sales return hasn't earned any revenue for the firm, so profit should also be reversed.

This article has been a guide to what is Sales Return Journal Entry. We explain it with example, credit memo and estimated points to understand regarding the concept. You can learn more about finance from the following articles –

• Journal Entry Format
• Sales Ledger
• COGS Journal Entry
• Expense Journal Entries