Purchase Return & Allowances

01 Api Purchase Return & Allowances

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 In for the shipping cost and credit cash or accounts payable depending on if we paid it now or later.

Remember, the rules for perpetual and periodic inventory still apply so we will look at both cases here. We will also look at the transactions from the seller and buyer’s perspectives. To illustrate the periodic inventory method journal entries, assume that Hanlon Food Store made two purchases of merchandise from Smith Company. Now, let’s look at the entry from Whistling Flute’s perspective. As the seller, Whistling Flute needs to show not only the return of the inventory but also the reduction in sales.

The cash amount is the amount we owe – the return – the discount. “Primary line” injury occurs when one manufacturer reduces its prices in a specific geographic market and causes injury to its competitors in the same market. For example, it may be illegal for a manufacturer to sell below cost in a local market over a sustained period. Businesses may also be concerned about “secondary line” violations, which occur when favored customers of a supplier are given a price advantage over competing customers. Operating expenses – Expenses incurred in the process of earning sales revenues. Nonoperating activities -Various revenues, expenses, gains, and losses that are unrelated to a company’s main line of operations. Purchase allowance – A deduction made to the selling price of merchandise, granted by the seller so that the buyer will keep the merchandise.

Gross Method

Sales returns and allowances – Purchase returns and allowances from the seller’s perspective. Thus, if sales are to be reported separately from the income statement, the amount should be reported as net sales. Involves more constant data update and is a far superior business management tool.

In theory, sellers could record both sales returns and sales allowances as debits to the Sales account because they cancel part of the recorded selling price. However, because the amount of sales returns and sales allowances is useful information to management, it should be shown separately. Account Debit Credit Sales Returns and Allowances 300 Cash (300 – 6) 294 Sales Discount (300 x 2%) 6 To record a sales return from a customer who had taken a discount and was sent a cash refund. The debit to the Sales Returns and Allowances account is for the full selling price of the purchase. The $6 credit reduces the balance of the Sales Discounts account and the balance is the cash refund.

Cost of goods sold is not the price charged to customers but what a company paid for the goods they are now selling. Sales Discounts and Sales Returns and Allowances are contra-revenue accounts meaning they are REVENUE accounts but debits will increase and credits will decrease. Sales are recorded in a Sales Revenue account and is the price we charge to the customers. Sales can be cash or have credit terms using Accounts Receivable since we will receive money from the customer in the future. To record sales, we will debit Cash or Accounts Receivable, depending on payment, and credit Sales Revenue.

Presentation Of Gross Sales And Net Sales Information

Under period inventory, we do not record changes in inventory until the end of the period, so this entry is fairly simple. Essentially, we are reversing a portion of the original purchase journal entry. A retailer ordered 10 items at a cost of $15 each from one of its suppliers. A week after receiving the items, the retailer discovered that one of the items had a flaw.

This would be based on the total invoice amount for all goods purchased during the period, as identified from the Purchases account in the ledger. The cost of the purchases is increased for the freight-in costs.

Because we want to preserve the original sales data and track returns, we are going to use a contra account called Sales Returns and Allowances to record the revenue portion of the transaction. The value being returned to inventory is the cost that Whistling Flute paid for the inventory, which is $400. An allowance is a reduction in price granted by the seller to the buyer. The original purchase must be reduced on the books by the amount of the allowance. This is done by recording the amount of the allowance in the purchases returns and allowances account. Purchases returns and allowances is a contra account to purchases.

Sales Returns And Allowances

We are not tracking physical quantities of inventory here. In both cases the dollar value of the inventory has changed, so the entry is the same. The cost of all purchases must ultimately be allocated between cost of goods sold and inventory, depending on the portion of the purchased goods that have been resold to end customers. This allocation must also give consideration to any beginning inventory that was carried over from prior periods. Freight cost incurred by the seller is called freight-out and is reported as a selling expense that is subtracted from gross profit in calculating net income. A potentially significant inventory-related cost pertains to freight. The importance of considering this cost in any business transaction is critical.

When the retailer notified the supplier, the supplier requested that the retailer donate or discard the item and the supplier will issue a credit memo for $15. Merchandise purchased from a seller is incomplete or short.

• The seller must inform all of its competing customers if any services or allowances are available.
• Have a deep awareness of the form and content of a detailed income statement.Be able to prepare closing entries for a merchandising concern.
• One to record the sale to the customer and one to record the usage of inventory as a cost of goods sold.
• Even if a merchant is selling goods at a healthy profit, financial difficulties can creep up if a large part of the inventory remains unsold for a long period of time.
• Under the perpetual method, we must always track changes to the cost of inventory.
• Notice that the seller was in Chicago and the purchaser was in Dallas.

Remember, the credit terms provides information to the buyer about when the invoice is due and if there is a discount allowed for paying the invoice if purchase allowances are granted, the buyer need not return the goods to the seller. early. The discount is not recorded until payment is received because the seller does not know if a buyer will take the discount or not.

Gross Vs Net

The retailer will combine the debit balance in its Purchases account with the credit balance in Purchase Allowances to arrive at the retailer’s net purchases. Perpetual inventory system – An inventory system under which the company keeps detailed records of the cost of each inventory purchase and sale and the records continuously show the inventory that should be on hand. On May 21, Hanlon purchased $20,000 of merchandise for cash with shipping terms FOB Shipping Point.

A purchase return occurs when a buyer returns merchandise to a seller. When a buyer receives a reduction in the price of goods shipped but does not return the merchandise, a purchase allowance results. The supplier records the credit memo with a debit to Sales Allowances and a credit to Accounts Receivable. The supplier will combine the debit balance in its Sales Allowances account with the credit balance in its Sales account to arrive at its net sales. This kind of price discrimination may give favored customers an edge in the market that has nothing to do with their superior efficiency.

Price discriminations are generally lawful, particularly if they reflect the different costs of dealing with different buyers or are the result of a seller’s attempts to meet a competitor’s offering. Other revenues and gains – A nonoperating-activities section of the income statement that shows revenues and gains unrelated to the company’s main line of operations. A company may elect to present its gross sales, deductions, and net sales information on separate lines within its income statement. However, doing so takes up a considerable amount of space, so it is much more common to see a net sales presentation, where the gross sales and deduction amounts are aggregated into a single net sales line item. All three of the deductions are considered contra accounts, which means that they have a natural debit balance ; they are designed to offset the sales account. Take a moment and look at the invoice presented earlier in this chapter for Barber Shop Supply. Notice that the seller was in Chicago and the purchaser was in Dallas.

Accounting, Financial, Tax

When a company sells merchandise to a customer, the seller provides credit terms. Remember, terms tell a buyer when the invoice is due and if there is a discount allowed for paying early. Discounts are not recorded until payment is received since the seller does not know if the buyer will take the discount at the time of the sale. You would have a sales returns and allowances account and a purchases returns and allowances accounts. If the inventory is returned to A, it will end up being counted in ending inventory. If it is not returned to A, it would count as cost of goods sold.

One to record the sale to the customer and one to record the usage of inventory as a cost of goods sold. A purchase allowance is a reduction in the buyer’s cost of merchandise that had been purchased. The purchase allowance is granted by the supplier because of a problem such as shipping the wrong items, an incorrect quantity, flaws in the goods, etc. In the case of a purchase allowance, the buyer does not return the merchandise to the supplier.

Bill’s Bikes sells a full line of road and mountain bikes. When new shipments of bikes arrive from his suppliers, Bill examines each one in detail because he knows they don’t always get his orders right. Sometimes they send the wrong items, other times goods may be defective or damaged. One is to send the unsatisfactory goods back to the supplier. The other is to keep the unsatisfactory merchandise in return for a price reduction from the supplier. The price reduction from the supplier is called an allowance. The discount is calculated based on the amount owed less the return x 2%.

A larger company will usually have an automated payment system where checks are scheduled to process concurrent with invoice discount dates. Very large payments, and global payments, are frequently processed as “wire transfers.” This method enables the purchaser to retain use of funds until the very last minute.

Seller Entries Under Perpetual Inventory Method

Therefore, the Inventory account would continue to carry the beginning of year balance throughout the year. As a result, Inventory must be updated at the time of closing. These entries accomplish that objective by crediting/removing the beginning balance and debiting/establishing the ending balance.

He also needs to debit accounts payable to reduce the amount owed the supplier by the amount that was returned. Because of all the new income statement-related accounts that were introduced for the merchandising concern, it is helpful to revisit the closing process. Recall the objective of closing; to transfer the net income to retained earnings and to reset the income statement accounts to zero in preparation for the next accounting period. As a result, all income statement accounts with a credit balance must be debited and vice versa. Several items are highlighted in these journal entries and are discussed further in the next paragraph. In total, these deductions are the difference between gross sales and net sales. If a company does not record sales allowances, sales discounts, or sales returns, there is no difference between gross sales and net sales.