This video shows how to account for Sales Returns and Allowances using journal entries. A sales return occurs when a customer returns an item to the company. A sales allowance occurs when the company reduces the price paid by a customer because the customer received defective merchandise. Sales Returns and Allowances are subtracted from Gross Sales on the Income Statement to obtain Net Sales.

Recording a Sale

On an Income Statement, you might see an account called “Sales Returns and Allowances” being subtracted from Gross Sales to obtain Net Sales.  Sales returns occur when customers return items to the company (e.g., “this facial cream didn’t work, it promised to make me look like Tom Cruise”) or when the company grants a price reduction to a customer for defective merchandise (e.g., “the birthday cake arrived in good condition, but half of it had already been eaten.  Can you knock a few dollars off the price?”).

Even though companies know there will probably be some sales returns and allowances, they don’t typically set up an allowance account upfront.  Instead, they record sales at their gross amount.  For example, let’s say your company sells $50,000 of self-driving baby strollers.

Journal Entry to Record Sale:
Accounts Receivable$50,000
 Sales Revenue$50,000

Recording a Sales Return

Now let’s assume that one of the customers returns a $12,000 purchase.

Journal Entry to Record Sales Return:
Sales Returns and Allowances$12,000
 Accounts Receivable$12,000

Recording a Sales Allowance

Let’s further assume that after this return was made, the company realizes that some of its self-driving baby strollers are defective (for some reason, they have a mind of their own and always drive to a U2 concert if Bono and his band are in town).  The company anticipates that some customers will complain about this and that it will reduce the amount they owe by $7,000 to make them happy, so now it sets up an allowance account.

Journal Entry to Record Sales Allowance:
Sales Returns and Allowances$7,000
 Allowance for Sales Returns and Allowances$7,000

Income Statement

After all of these transactions, the top of the Income Statement will look like this:

Gross Sales$50,000
Sales Returns and Allowances($19,000)
Net Sales$31,000