Accounting and Finance Foundations

Unit 7

Accounting and Finance Foundations Unit 7: Financial Statements 549

Financial Statements

Chapter 18

Student Guide

Sales Returns and Allowances

The Sales Returns and Allowances account—which is used

in both the periodic and perpetual inventory systems—tracks

product returns made by customers who were not satisfied with

products, along with allowances (discounts) given to other dis-

satisfied customers in lieu of them returning their purchases. The

account, a contra-revenue account, has a normal debit balance

and is deducted from sales or revenues. (Remember: A contra

account is an account that offsets another account.) A contra-

asset account has a credit balance and offsets the asset with a

debit balance. A contra-liability has a debit balance and offsets

the credit balance of the corresponding liability. A contra-revenue

account would offset revenues with a debit balance and the cor-

responding revenue account.

Under the perpetual inventory system, if a customer returns a product, the value of that product will be

transferred back into the inventory account—as long as the returned product can be resold. You would

record a product return as the following journal entry:

Debit Credit

06/22/20YY

Sales Returns and Allowances $2,000

Accounts Receivable 2,000

Record the Return of Product X from Customer Z.

The Sales Returns and Allowance account is used to determine the net sales, or net revenues. Net rev-

enues are total sales less the sales returns and allowances. You would present the net revenues on the

income statement in the Revenue section as follows:

ABC Company

Income Statement (Partial Statement)

December 31, 20XX

Revenues

Gross Sale 125,000

Less: Sales Returns and Allowances (2,000)

Net Revenues $123,000

Bad Debt and Uncollectible Receivables

The preferred method for accounting for uncollectible or bad debt expense is the allowance method of

accounting for bad debts, which is based on experience according to US GAAP. To calculate the bad debt

or uncollectible receivables, you should use a percentage of the accounting period’s sales. Using this

approach (called the percentage of sales method), a percentage of each sale is debited to the Bad Debt

Expense account recorded on the income statement and credited to the Allowance for Doubtful Accounts

on the balance sheet.

The Income Statement Lesson 18.1 (cont’d)