Returns of StockChapter 13

Two Types

There are basically two types of returns: purchase returns and sales returns.

A purchase return occurs when stock is returned to a supplier (by our firm).

A sales return occurs when stock is returned by a customer (to our firm).

This chapter concentrates on how to record and report purchase returns to trade creditors, and sales returns by trade debtors.

(Returns for a cash refund are beyond the scope of this course.)

Reasons for Returns of Stock

There are probably as many reasons for returning stock as there are for purchasing it in the first place. Some of the more common reasons to return stock may be because:

the stock is faulty/damaged

the stock is the wrong size/colour/shape/model

too many items of stock were purchased

customers have simply changed their minds!

Damaged or faulty stock must be accepted for return, provided the customer has the source document as proof of purchase (e.g. the sales invoice), and the business is satisfied the fault lies with the product, and not how it was used. It is up to individual businesses to decide whether they will accept return from customers who have changed their minds.

Reasons for Returns of Stock

You!Review Questions 13.1

Q’s 1,2 & 3.

Credit Notes

As with all transactions, the process of recording and reporting returns of stock must begin with a source document. As this course deals only with credit returns (to trade creditors and by trade debtors), the only document to provide the evidence of a return will be a credit note such as the one shown in Figure 13.1 (p. 293).

Every credit note must identify the type and quantity of stock returned, the customer who is returning the stock, and the reason for the return.

Purchase or Sales Return?

Given that a credit note will provide the evidence of both a purchase return and a sales return, how are the two to be distinguished?

Note how similar a credit note is in appearance to an invoice, and just like an invoice, the name of the seller is identified at the top of the document. In the case of a return, the seller is also the business that is receiving the stock as a return. The business returning the stock is identified in the middle of the credit note.

If our business name is in the middle of the credit note, we are returning the stock, and the transaction is a purchase return.

If our business name is at the top of the credit note, we are receiving the stock in return, so the transaction is a sales return.

Recording purchase returns

to trade creditorsA purchase return will reduce the quantity of stock on hand, and also reduce the amount owed to the trade creditor. In addition, it will effect the balance of the GST Clearing account.

Stock cardsAs with all transactions affecting stock, a purchase return must be recorded in the stock card of the appropriate stock item. In the accounting records for Pete’s Tyre Mart, this purchase return would be recorded in the stock card as shown in Figure 13.2.

Stock cards

Stock cards

As the stock leaves the firm to return to the supplier, it is recorded in the OUT column of the stock card, thereby decreasing the quantity of stock on hand. Note that it is only the cost price of the stock ($80 per tyre) that is recorded in the stock card – the GST component is excluded.

FIFOThe credit note must identify the cost price of the stock that is being returned. This means that returns may come from the stock which was purchased first but, equally, may come from newer batches of stock. Effectively, FIFO (first-in, first-out) is not applied to purchase returns.

The General Journal

While there is a special journal dedicated to recording credit purchases of stock – the Purchases Journal – purchase returns are recorded in the General Journal because they don’t involve cash and, hopefully, are infrequent. The purchase return recorded in the stock card in Figure 13.2 would be recorded in the General Journal as shown in Figure 13.3 p. 295.

The General Journal

General LedgerIt is important that the narration identifies the source document (Credit note 11) so the actual stock item can be identified and recorded in the stock card.

In terms of the General Ledger, a purchase return is simply the reversal of a purchase.

To begin with, returning the stock to the supplier reduces the amount that is owed to that supplier. This is recorded as a debit to Creditor Control. Remember that the original amount owing to the creditor consisted of two amounts – the cost price of the stock ($1600), plus the GST ($160). Thus returning the stock decreases the creditor by the sum of these two figures ($1760). (This debit entry must also be recorded in the subsidiary ledger to decrease the balance owed to Creditor – Billstone Tyres.)

Are you having fun?

General LedgerBecause the stock level decreases, Stock Control decreases via a credit to this account, but this is only for the amount that actually relates to stock ($1600). That is, just like the stock card, the amount in the Stock Control account excludes the GST component. This GST amount ($160) is recorded as a separate credit to GST Clearing increasing the liability to the ATO (or possibly reducing the asset).

The transaction in Figure 13.3 would be posted to the ledger accounts as shown in Figure 13.4 and Figure 13.5 (p. 296). Note that the cross-reference Creditors Control now appears on both sides of the GST Clearing account: the GST on incurred on credit purchases ($3500) is on the debit side (as a reduction in the GST liability), and the GST on purchase returns ($160) is on the credit side.

General Ledger

See Figure 13.5 purchase return in the Creditors Ledger (p. 296).

Note we no longer owe the creditor for the stock, and we no longer owe the creditor for the GST on that stock. Thus the cross-reference is Stock Control/GST Clearing. Note there is no ledger account called ‘Purchase returns’.

See also effect on the accounting equation.

Reporting

Because a purchase return does not affect any revenue or expense items, and does not involve a cash flow, it will not be reported in either the Cash Flow Statement or the Profit and Loss Statement. In fact, it will not be reported anywhere! A purchase return will effect the balances of Stock, Creditors and GST in the Balance Sheet, but will not be reported as a separate item.

You!Review Questions 13.3.

Q’s 2 & 3.

Recording trade returns from debtors

Whereas a purchase return occurs when stock is returned to a trade creditor, a sales return occurs when stock is returned by a trade debtor. This will increase stock on hand, but reduce debtors and also Net profit. The balance of the GST Clearing account will also be effected.

As stock is coming back into our business, a sales return must be recorded in the IN column of the relevant stock card. In the accounting records for Books By Gosh, this sales return would be recorded in the stock card as shown in Figure 13.6 (p. 298).

Recording trade returns from debtors

Note that although the credit note identified the price of each book as $30, this is the selling price: transactions must be recorded in the stock card at cost price.

So, which cost price should be used? In Figure 13.6, the original sale on 4 May 2010 valued the stock at a cost price of $10 per book. Why then, isn’t this cost price used in the sales return on 23 May 2010?

The key principle behind recording a sales return is that the stock card should be returned to the position it would have been in if the sale had never taken place. If the sale on 4 May 2010 had not taken place, then we would assume that the $10 stock would still be on hand. However, the application of FIFO (first-in, first-out) would simply assume that this stock would be part of the next sale on 13 May 2010.

In practice, this means that sales returns should value stock at the cost price used in the most recent transaction in the OUT column. If the most recent sale involved two different cost prices, then a reversal of FIFO assumes that the last stock out is the first stock to be returned.

So…

A sales return should value stock at the cost price used in the most recent transaction in the OUT column.

Using the cost price in the most recent transaction in the OUT column means that the sales return on 23 May 2010 should use the cost prices from the sale on 18 May 2010, valuing 2 of the items at $14 each (the last 2 books sold), with the other valued at $12. The total cost price of the return – $40 – will be used in the General Journal entry.

The General JournalCredit sales are recorded in their own journal – the Sales Journal – but like purchase returns, sales returns are recorded in the General Journal.

The sales return recorded in the stock card in Figure 13.6 would be recorded in the General Journal as shown in Figure 13.7 (p. 299).

The original credit sale was recorded as a credit to the Sales revenue account, so a sales return requires the opposite. But rather than simply debit the Sales revenue account, a separate ledger account is used to record Sales returns. This account is a negative revenue account, and is debited ($90) to record the reduction in revenue. At the same time, GST Clearing is also debited ($9) to reduce the GST liability owed to the tax office.

The General JournalReversing the sale also means that the debt owed by the debtor is reduced. This is achieved by crediting the Debtors Control account in the General Ledger, and simultaneously crediting the individual account (Debtor – M.S. Howard) in the Debtors Ledger. The debtor owed us both the selling price ($90) as well as the GST on the sale ($9), so by returning the stock, the full amount ($99) is deducted from their balance.

Just as a credit sale involves two double entries – one at cost price and one at selling price – so does a sales return. The cost price – $40 as determined via the stock card – is debited to the Stock Control account to reflect that the stock is coming back IN to the business. As a consequence, the expense Cost of sales is reduced via a credit entry (because the sale has been returned). Again, the entries affecting the Stock Control account do not include GST.

Ledger Accounts

The transaction in Figure 13.7 would be posted to the ledger accounts as shown in Figure 13.8 and Figure 13.9.

Note the cross-reference Debtors Control appears on both sides of the GST Clearing account: GST charged on credit sales increases the GST liability via an entry on the credit side, but GST on sales returns decreases that liability via an entry on the debit side.

Debtors Ledger

See Figure 13.9 Sales return in the Debtors Ledger.

Note how the cross-reference for the credit entry in both debtor accounts (in the General Ledger and Debtors Ledger) is Sales returns/GST Clearing reflecting the fact that both the selling price of the stock ($90) and the GST component ($9) have been deducted from the debtors’ balance.

See also the effect on the accounting equation.

You! Review Questions 13.4 (all).

Reporting Sales ReturnsThe value and number of stock returns can be an important indicator of the quality and suitability of the stock that is being traded. If sales returns are high, it may indicate customer dissatisfaction with the goods that are being sold. This may be because the goods are of inferior quality, or simply because customers have been provided with goods that did not suit their purpose.

In order to investigate the cause of high sales returns, the owner must first be aware that sales returns are indeed a problem. This is why Sales returns is recorded in its own separate ledger account, and reported separately in the Profit and Loss Statement.

Figure 13.10 shows how sales returns are reported in the Profit and Loss Statement. As a negative revenue, Sales returns is reported as a deduction from Sales revenue, leaving Net sales. In Figure 13.10, this Net sales figure is $50 910.

Note: The Cost of sales figure of $23 960 is inclusive of the sales return. That is, the cost price of the sales return has already been deducted from the overall Cost of sales figure.

You!

Review Questions 13.5 (all).

Read Summary.

Do end of chapter exercises (at least five).

Read Where are We Headed (Chapter 14).