Returns of Stock
Chapter 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 creditors
A 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 cards
As 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.
FIFO
The 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 Ledger
It 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 Ledger
Because 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 Journal
Credit 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 Journal
Reversing 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 Returns
The 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).