In accounting, the central activities of every trade or manufacturing organisation are purchasing and selling, which form the basis of generating revenues and incurring operating costs. Purchases simply mean the materials that are purchased by a business from suppliers with the aim of resale or utilising them in manufacturing. Purchases can either be paid in cash or on credit, forming an essential part of the cost base of the company. On the other hand, sales refer to the products or services offered to customers in return for money, which form the main income of the majority of businesses.
However, in actual commercial transactions, not all purchases and sales are final. Products can be returned because they are faulty, damaged, more than needed, or because they do not agree with the order description. This creates purchase and sales returns. Purchase returns, also termed outbound returns, happen when products purchased from suppliers are returned, thus reducing the overall purchases and obligations due to creditors. Sales returns, or inward returns, take place when customers return goods to a company, thus lowering the overall sales revenues and receivables or cash balance.
In order to ensure accuracy and transparency, the accounts of purchases, sales, and returns are kept separate. Purchase Returns Account and Sales Returns Account serve as reverse accounts for Purchases and Sales, respectively, such that only net purchases and net sales are carried forward in the financial statements. These accounts, coupled with debit and credit notes, play a pivotal role in ensuring the true financial status of a company is duly represented.
Purchase Returns in Accounting
In accounting, purchase returns or returns outbound are the products that a company has purchased and then returned to the vendor. The condition occurs when the products received are defective, damaged, of low quality, excess, or do not fulfil the required standards. Since such commodities are no longer part of the company’s usable inventory, they are returned and the supplier either deducts the amount of payment or offers a credit note in return. Purchase returns thus reduce recorded total purchases in the company’s accounting books, thus affecting the company’s liabilities against creditors.
Debit notes in case of purchase returns
When merchandise is returned to a vendor, the purchasing organisation releases a debit note. A debit note is an official document that indicates the buyer has credited the account of the supplier, thus decreasing the amount due. It acts as proof of return and allows both organisations to keep proper records. The customer is issued a debit note notifying the supplier of goods returned. The supplier recognises the return of goods by the buyer and expects a credit note.
Later, the supplier issues a credit note to the buyer, verifying the acceptance of the return and correcting the balance outstanding.
Journal Entries for Purchase Returns
In accounting, purchase returns are recorded in the Purchase Returns Account (or Returns Outward Account). This is a contra account to Purchases, indicating that it reduces the total purchases appearing in the financial statements.
1. When goods are returned:
Journal entry to reduce the liability to the supplier:
Accounts Payable (Supplier A/c) Dr.
To Purchase Returns A/c
Here, the supplier’s account is credited (thus decreasing the amount payable) and the Purchase Returns account is debited.
2. Situations where products are bought for cash and are then returned, the return is recorded as follows:
Cash/Bank A/c Dr.
To purchase the returns account
Example –
Suppose a company purchases goods on account from Supplier X for ₹50,000. When about ₹5,000 worth of goods are returned as defective, the journal entry would be made as follows:
Journal entry –
Supplier X A/c Dr. ₹5,000.
To Purchase Returns Account ₹5,000.
Purchase returns are also important in business accounting since they ensure that there is accuracy in purchasing records and obligations. Use of debit notes and journal entries ensures openness and accurate record-keeping between buyers and suppliers. Firms that keep accurate records of purchase returns ensure that they only have legitimate and worthwhile goods in their inventory and that the accounts of the suppliers are correctly updated.
Sales Returns in Accounting
In accounting, sales returns are also known as returns inward, referring to returned products sold to customers that are returned to the vendor. Returns can be due to many reasons, such as defective items, damage during shipping, wrong specifications, quality problems, or oversupply. Sales returns directly affect the seller’s income; hence, they are recorded separately in a Sales Returns Account, serving as a counter-entry to the sales account. This way, the company ensures that it reports correctly the net sales (gross sales less sales returns) in its financial statements, hence presenting a better picture of the real income earned.
Credit notes where sales returns occur
Where a vendor receives returned goods from a buyer, the seller sends out a credit note. This report informs the buyer that the account has been credited (decreased) by the amount of the returned goods.
A credit note is used for:
- Documents returned goods.
- Credits the customer’s account.
- Records the return sale legally and for accounting purposes.
For example, if a customer brings back goods worth ₹4,000 on return of a purchase of ₹20,000, the seller will debit a credit note of ₹4,000, thus decreasing the liability of the buyer or returning any cash already paid.
Journal Entries for Sales Returns
1. When goods are returned by a credit customer:
Sales Returns A/c Dr.
To Accounts Receivable (Customer A/c)
(Records the return and decreases the amount receivable from the customer.)
2. Where cash customers return goods:
Sales Returns Account Dr. To Cash/Bank Returns are recorded and paid back to customers through cash or bank transfer.
3. In accounting, sales returns are subtracted from gross sales to arrive at net sales.
Example –
Take goods worth ₹50,000, which were sold on credit to Customer Y. Later on, goods amounting to ₹5,000 were returned.
Journal Entry –
Sales Returns A/c Dr. ₹5,000
To Y A/c ₹5,000
This does make sure that revenue and receivables are properly adjusted.
Sales returns are a very important element of accounting that ensures that the revenue reported is not exaggerated. The use of credit notes and proper journal entries instils transparency between the buyer and the seller, while the Sales Returns Account allows the firms to reflect their financial record properly by indicating only net sales.
Purchase Returns Vs Sales Returns
Purchase returns cause the total purchases to decrease, whereas sales returns cause the sales amounts to decrease. Purchase returns call for a debit note on the part of the buyer, while sales returns call for a credit note on the part of the seller. Both returns act as counter accounts so that financial records are an accurate reflection of net purchases and net sales, hence giving an overall picture of the company’s performance.
| Aspect | Purchase Returns (Returns Outward) | Sales Returns (Returns Inward) |
|---|---|---|
| Definition | Goods purchased but returned to the supplier due to flaws, wrong quality, excess supply, or incorrect order specifications. | Goods sold to customers but returned by them due to defects, wrong quality, damage, or excess quantity. |
| Viewpoint / Perspective | Recorded in the buyer’s books of accounts. | Recorded in the seller’s books of accounts. |
| Account Used | Purchase Returns Account (a reverse/contra account of Purchases). | Sales Returns Account (a contra account of Sales). |
| Impact on Accounts | Reduces total purchases and liabilities towards suppliers (in case of credit purchases). | Reduces total sales revenue and decreases receivables (credit sales) or requires cash refunds (cash sales). |
| Supporting Document | Buyer issues a Debit Note to the supplier, stating the adjustment of returned goods. | Seller issues a Credit Note to the customer, stating the customer’s account has been credited for returned goods. |
| Journal Entry | When goods are returned to the supplier: Accounts Payable (Supplier A/c) Dr. To Purchase Returns A/c | When goods are returned by the customer: Sales Returns A/c Dr. To Accounts Receivable/Customer A/c |
| Financial Statement Impact | Deducted from Purchases to arrive at Net Purchases. | Deducted from Sales to arrive at Net Sales. |
Conclusion
Purchase and sales returns are a natural component of the day-to-day business, given that not all transactions will finish with the acceptance of goods without problems. Purchase returns enable organisations to capitalise on defective, excess, or unsuitable goods, so that they can accurately reflect commitments to suppliers. On the other hand, sales returns protect customers’ interests by enabling them to bring back products that are not satisfactory to them, as well as ensuring that sellers do not overstate their revenue.
Both returns are routinely recorded by way of debit and credit notes supported by appropriate journal entries and reflected in the form of contra accounts in financial statements. With the reduction of purchase returns from total purchases and sales returns from total sales, companies can disclose their actual trading results. Efficient management of returns not only adds to the financial transparency but also fosters trust and accountability among buyers and sellers.
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