Sales discounts, returns, and allowances
Real sales involve discounts, returns, and price adjustments. Accounting for them correctly gives an accurate picture of revenue.
Gross and net sales
Gross sales are total sales at invoice prices. Net sales are gross sales minus sales returns and allowances and sales discounts. Reporting net sales shows the revenue a business actually expects to keep.
Sales returns and allowances
A sales return occurs when a customer sends goods back; a sales allowance is a price reduction given when a customer keeps damaged or unsatisfactory goods. Both are recorded in a contra-revenue account, Sales Returns and Allowances, which has a debit balance and reduces sales, keeping a record of how often problems occur.
Returns under a perpetual system
When goods are returned and can be resold, two entries are made: debit Sales Returns and Allowances, credit Accounts Receivable (or Cash); and debit Merchandise Inventory, credit Cost of Goods Sold, restoring the goods to inventory at cost.
Credit terms and discounts
Credit terms such as '2/10, n/30' mean the buyer may take a 2% discount if paying within 10 days; otherwise the full amount is due in 30 days. Sellers offer such discounts to encourage early payment. The annualised cost of skipping a 2/10, n/30 discount is very high, roughly 37%, so buyers usually take it if they can.
Recording sales discounts
If a customer owing 1,000 dollars on terms 2/10, n/30 pays within 10 days, the seller receives 980: debit Cash 980, debit Sales Discounts 20, credit Accounts Receivable 1,000. Sales Discounts is another contra-revenue account. The buyer records a lower cost of inventory for the discount taken.
Trade discounts
Trade discounts are reductions from list prices offered to certain customers, such as wholesalers, and are not recorded separately: the sale is simply recorded at the discounted price. Only cash (early payment) discounts are tracked in Sales Discounts.
Sales taxes and revenue
Sales taxes collected from customers are not revenue; they are owed to the government. The seller records them as a liability (Sales Taxes Payable) until paid. Similarly, value-added tax (VAT) collected in many countries is a liability.
Worked example
A wholesaler sells goods for 5,000 dollars on terms 2/10, n/30; the goods cost 3,000. The customer returns 500 dollars of goods (cost 300), then pays the balance within 10 days. Net receivable = 4,500; discount = 2% x 4,500 = 90; cash received = 4,410. Net sales = 5,000 - 500 - 90 = 4,410; COGS = 2,700; gross profit = 1,710.
Key takeaways
Net sales = gross sales - returns and allowances - sales discounts. Returns and allowances and sales discounts are contra-revenue accounts with debit balances. Perpetual returns restore inventory at cost. Terms like 2/10, n/30 offer early payment discounts with high implied interest. Trade discounts are not recorded separately. Sales taxes collected are liabilities, not revenue.
Flashcard
Total sales at invoice prices
Check your understanding
A customer owes 2,000 dollars on terms 2/10, n/30 and pays within 10 days. How much cash does the seller receive?