Understanding sales returns and allowances

Definition

Sales returns and allowances is the account a shop uses when a customer sends goods back or is granted a price concession on a ticket already billed. On the books, this is a contra-revenue account, a subtraction from billed revenue on the Income Statement, not an expense.

A clothing boutique that takes back a $150 dress reduces billed sales by $150. The dress coming back onto the rack is a separate inventory story.

Cash-basis books may only show the cash that leaves or never arrives. Accrual books raise this contra and lower accounts receivable when the ticket is reversed or reduced.

This line cuts billed sales. It is not rent, wages, or another cost sitting below the top of the P&L.

Where it shows up

Balance Sheet: Related to reducing the receivable when the sale is reversed or reduced.

P&L: Located as a reduction of billed sales.

See also: Credit Memo · Net Revenue · Revenue

When you look at your Income Statement, this account sits under billed sales and brings the total down to net revenue. It does not appear with operating expenses.

When the balance is high, more tickets were sent back or reduced in the period. When it is low, most billed sales stayed on the books at the original amount.

The Balance Sheet does not keep this as a permanent account after the close. The related change is a smaller receivable when the sale is reversed or reduced.

The profit and loss statement is the home for this contra. After the close, it resets with the other revenue accounts.

A return that also sends cash back will show as an operating outflow on the Statement of Cash Flows. A return that only cancels an unpaid invoice does not move cash.

How it works

The contra gets onto the books when the shop accepts the return or grants the allowance. The bookkeeper debits this account and credits accounts receivable, or cash if the customer already paid and is refunded.

That debit is a reduction of billed sales. It is not an expense, and it does not rewrite the original sales credit.

A credit memo is often the document behind the entry. It tells the customer, and the books, that the amount owed just fell.

An allowance is a price concession without taking the goods back. The boutique keeps the dress sold and still cuts the ticket through this same account.

A return of goods that can be sold again also puts inventory back on the Balance Sheet and reverses the related cost of goods sold. That inventory entry is a different journal from this contra.

Stay with the cut to billed sales when you read this line. The rack story is inventory; this line is the revenue subtraction.

A debit memo is the opposite document: it raises what the customer owes. This contra is the revenue cut, not that extra charge.

A write-off is also not this line. A write-off removes a balance you will not collect; this account records a return or concession you agreed to.

A chargeback can look similar when a card issuer reverses a sale. The books still need a contra or a reversal so billed sales do not stay overstated.

After the close, this account returns to zero. Next month's returns start the contra again.

Keep the credit memos and return slips that support the period total. Anyone tying net revenue to the invoices should be able to see which tickets came back or were reduced.

Do not park a return in an expense account because it feels like a loss. The P&L already has a place for it, right under billed sales.

Example

A clothing boutique billed $150 for a dress on Friday. On Monday the customer brings it back unused, and the shop issues a credit memo.

The return of the billed ticket is recorded:

Debit: Sales returns and allowances $150

Credit: Accounts receivable $150

Billed sales for the week still include the original $150. This contra brings net revenue down by $150.

If the customer had already paid, the credit would hit cash instead of the receivable. The P&L effect is the same: billed sales are reduced, not expensed.

The dress back on the rack is a separate inventory entry. This page's journal is only the contra-revenue cut.

Common mix-ups

Sales returns and allowances is not an expense. Expenses sit below the top of the P&L; this account reduces billed sales.

This line is not sales discounts. Sales discounts are the early-pay or price-cut contra; this line is goods sent back or a concession on the ticket.

This line is not the inventory return by itself. Inventory coming back is an asset story; this account is the revenue subtraction.

Related terms

• Credit Memo: A document that reduces what a customer owes.
• Debit Memo: A document that increases what a customer owes or adjusts a vendor balance.
• Write-Off: Removing a balance from the books when it will not be collected or paid.
• Net Revenue: Gross sales after returns, discounts, and allowances are subtracted.
• Gross Revenue: Total billed sales before returns, discounts, and allowances.
• Revenue: The total value of goods and services the business earned in a period.
• Accounts Receivable: Money customers owe the business for goods or services already delivered.
• Income Statement: A statement showing revenue earned and expenses incurred over a period, ending in net income.
• Cost Of Goods Sold: The direct cost of the products sold during the period.
• Chargeback: A card payment reversed at the customer's request.