Sales returns and allowances: the journal entries, step by step

Not every sale sticks. A customer sends back the wrong size, a shipment arrives scratched, a supplier ships twelve boxes when you ordered ten. Each of these events undoes part of an earlier sale or purchase, and each one needs a journal entry that reverses exactly the right amount in exactly the right accounts. This page walks through the four entries you will meet most often: the sales return, the sales allowance, the purchase return and the purchase allowance. It uses a perpetual inventory system throughout, then shows what changes under a periodic system.

If you can already record a sale on account and the cost of goods sold that goes with it, you have everything you need. A return is mostly that same entry run backwards, with one twist: the revenue side goes into its own account instead of straight back into Sales Revenue.

Return or allowance: what is the difference?

A return means goods physically come back. The buyer gives up the goods and, in exchange, owes less (or gets a refund). An allowance means the goods stay where they are. The buyer keeps them, usually because they are slightly damaged or not quite what was ordered, and the seller cuts the price to keep the customer happy.

That one difference drives the whole entry:

• In a return, inventory moves. Under a perpetual system, the seller has to put the goods back into Inventory and take their cost out of Cost of Goods Sold.
• In an allowance, no inventory moves. Only the price changes, so only the revenue and the receivable (or cash) change.

Whenever you read one of these transactions, ask first: did the goods come back? The answer tells you whether you need two lines or four.

Why sellers use a contra-revenue account

You could record a return by debiting Sales Revenue directly. The ledger would still balance, and net sales would be right. Most businesses do not do it that way, because it hides information. If returns are netted silently against sales, nobody can see that returns doubled last quarter, or that one product line is coming back far more than the others.

Instead, sellers debit Sales Returns and Allowances, a contra-revenue account. It has a normal debit balance (the opposite of revenue), and on the income statement it is subtracted from gross sales to give net sales:

Net sales = Sales Revenue − Sales Returns and Allowances − Sales Discounts

The result is the same as debiting Sales Revenue, but the gross figure and the returns figure both stay visible. That is the habit our exercises check: a debit to Sales Revenue is marked wrong, with feedback pointing you to the contra account.

The four entries at a glance

If the original sale was for cash and the customer gets money back, credit Cash instead of Accounts Receivable. If the original purchase was paid in cash and the supplier refunds you, debit Cash instead of Accounts Payable. Everything else stays the same.

Worked example: a sales return on account

Here is one problem from the practice set, exactly as the generator produced it:

Lakeside Outfitters sold 61 desk lamps on account at $116.00 each; they cost Lakeside Outfitters $58.00 each. The customer returned 19 of them in good condition for credit against the invoice, and they went back on the shelf. It uses a perpetual inventory system.

Step 1: the price side

The customer is returning 19 lamps that were billed at $116.00 each, so the invoice shrinks by 19 × $116.00 = $2,204.00. The receivable goes down (credit Accounts Receivable) and the reduction in revenue goes to the contra account (debit Sales Returns and Allowances).

Step 2: the cost side

When the sale was first recorded, a perpetual system also moved the lamps' cost from Inventory to Cost of Goods Sold. Now 19 lamps are back on the shelf, so that part has to be reversed at cost, not at selling price: 19 × $58.00 = $1,102.00. Debit Inventory, credit Cost of Goods Sold.

Step 3: the entry

Debits total $3,306.00 and credits total $3,306.00. Notice that the two pairs balance on their own: the price pair is $2,204.00 on each side and the cost pair is $1,102.00 on each side. The difference between them, $1,102.00, is the gross profit Lakeside Outfitters no longer earns on those 19 lamps.

Worked example: a sales allowance

Same company, different problem: the full order of 61 lamps was billed at $7,076.00, some arrived scratched, and the customer agreed to keep every lamp in exchange for a 20% allowance. The allowance is 20% × $7,076.00 = $1,415.20.

There is no Inventory line. The lamps never came back, so the cost already in Cost of Goods Sold is still correct.

Worked example: a purchase return

Now look at the other side of the counter. Lakeside Outfitters bought 61 lamps on account at $58.00 each, and 19 arrived damaged and went back to the supplier. The company owes the supplier 19 × $58.00 = $1,102.00 less, and it has $1,102.00 less inventory.

A purchase allowance looks exactly the same: the goods stay, but under a perpetual system their recorded cost falls by the allowance, so you still credit Inventory.

Perpetual vs periodic: what changes

Everything above assumes a perpetual system, where every purchase and sale updates the Inventory account immediately. Most businesses with point-of-sale or inventory software work this way, and it is the system our exercises use unless the problem says otherwise.

Under a periodic system, purchases go into a temporary Purchases account during the period, and Inventory is only updated after a count at the end. Two things change:

• Purchase returns and allowances are credited to a contra account, Purchase Returns and Allowances, instead of Inventory.
• Sales returns have no cost side at all. There is no Cost of Goods Sold entry at the time of sale, so there is nothing to reverse; the end-of-period count picks up the returned goods.

The sales-side contra account, Sales Returns and Allowances, is used under both systems.

Common mistakes

These are the errors our checker recognises in this lesson, each with its own feedback:

1. Leaving out the cost side of a return. Recording only the price pair leaves the returned goods missing from Inventory and overstates Cost of Goods Sold. If goods came back and can be resold, you need four lines.
2. Restocking at selling price. Inventory is carried at cost. Debiting Inventory for $2,204.00 in the example would invent $1,102.00 of inventory that never existed.
3. Debiting Sales Revenue. It balances, but it buries returns inside the revenue figure. Use the contra account.
4. Moving inventory for an allowance. The customer kept the goods. An allowance only changes the price.
5. Using Purchase Returns and Allowances under a perpetual system. That account belongs to the periodic method. With perpetual records, credit Inventory directly.
6. Reversing the whole invoice. Only the returned units (or the agreed allowance) come off. Read how many units came back.

How the practice works

Each exercise gives you a short scenario with numbers generated for you, so the problem changes every time you ask for a new one. You choose accounts from a standard chart of accounts, type each amount in the Debit or Credit column, and press Check. Your entry is compared line by line with the correct entry, computed from the same numbers. Line order does not matter, and a wrong account or side is highlighted so you can fix just that line.

The lesson builds up in four steps: a sales allowance (two lines), a purchase return or allowance, a sales return on account with its cost side, and finally a mix of cash refunds and returns on account where you have to work out what to credit.

A quick checklist before you press Check

• Did goods come back? If yes, and the system is perpetual, there is a cost pair at cost.
• Was the original sale for cash or on account? That decides whether you credit Cash or Accounts Receivable.
• Is the revenue reduction in Sales Returns and Allowances, not Sales Revenue?
• Did you multiply by the units returned, not the units sold?
• Do debits equal credits, and does each pair balance on its own?