Purchase returns and allowances
Purchases Returns and Allowances is a contra-purchases account used to record purchases returns and purchase allowances. It is reported as a deduction from Purchases on the income statement. We are simply looking at returns and allowances from the buyer's point of view[1].
Because purchases are an expense and normally carry a debit balance, a contra purchase expense will carry a credit balance[2].
Purchases returns and allowances decrease the amount of purchases. Therefore, Purchases Returns and Allowances is a contra account to Purchases. Thus, the normal account balance of Purchases Returns and Allowances is a credit, the opposite of the normal account balance Purchases, a debit. The account is in the cost of merchandise of Hobby Shack's chart of accounts
A purchase return or allowance should be confirmed in writing. A form prepared by the customer showing the price deduction taken by the customer for returns and allowances as a debit (deduction) on the vendor account to show the decrease in the amount[3]
Purchase disounts
This contra account reflects any discount a company receives because it pays a merchandise invoice early. It is the flip side of the contra revenue account "sales discount" -looking at the same event from the eyes of the customer rather than the seller.
The credit terms of a purchase on account may permit the buyer to claim a cash discount for prompt payment. The buyer calls this cash discount a purchase discount. This incentive offers advantages to both parties: The purchaser saves money, and the seller shortens the operating cycle by more quickly converting the accounts receivable into cash.
Credit terms specify the amount of the cash discount and time period in which it is offered. They also indicate the time period in which the purchaser is expected to pay the full invoice price. This means that the buyer may take 2% cash discount on the invoice price less ("net of") any returns or allowances if payment is made with 10 days of the invoice date ( the discount period). If the buyer does not pay in that time, the invoice price, less any returns or allowances, is due 30 days from the invoice date. Alternatively, the discount period may extend to a specified number of days following the month in which the sale occurs. For example, 1/10 EOM ( end of the month) means that a 1% discount is available if the invoice is paid within the first 10 days of the next month. When the seller elects not to offer a cash discount for prompt payment, credit terms will specify only the maximum time period for paying the balance due. For example, the invoice may state the time period as n/30, n/60, or n/10 EOM. This means, respectively, that the buyer must pay the net amount in 30 days, 60 days, or within the first 10 days of the next month[4].
Purchase allowance
The purchase allowance reduces the cost of the goods he purchased. The purchase supplement is called upon by the supplier due to problems such as
- late shipment of products,
- wrong quantity,
- defects of goods,
- damage, etc.
In the case of the purchase supplement, the buyer does not apply to the supplier's goods.
Examples of Purchase returns and allowances
- A manufacturer returning an item to a supplier because it was defective. This can be a purchase return or an allowance, depending on the terms of the agreement between the supplier and the manufacturer.
- A retailer offering a customer a discount on an item because it was damaged in transit. This is an example of a purchase allowance.
- A customer returning an item that they purchased because they changed their mind. This is an example of a purchase return.
Advantages of Purchase returns and allowances
Purchase returns and allowances have several advantages for businesses. *They provide businesses with an avenue to improve customer service and satisfaction by allowing customers to return items that are not satisfactory or to receive discounts for items that may be damaged or less desirable. *It also allows businesses to better manage their inventory levels by reducing the amount of stock that needs to be carried. *In addition, purchase returns and allowances can help businesses to save money by reducing the cost of goods sold, as returns and allowances are taken directly from the cost of goods. *Finally, purchase returns and allowances can help to protect businesses from losses due to faulty or damaged products, as customers can return the items for a full or partial refund.
Limitations of Purchase returns and allowances
Purchase returns and allowances are an important part of managing inventory and accounts payable, but there are some limitations to consider when using this account. These include:
- Difficulty tracking returns - Tracking returns can be difficult if the customer does not provide the original invoice or sales receipt.
- Time consuming - The process of verifying, processing and recording returns can be time consuming.
- No ability to recapture lost revenue - Once a purchase return or allowance is recorded, the revenue associated with the sale is lost.
- Difficulty forecasting cash flow - Purchase returns and allowances can be unpredictable and make it difficult to forecast cash flow.
- Lack of insight into customer behavior - Without tracking systems, it can be difficult to gain insight into customer behavior and preferences.
One approach to record purchases returns and allowances is by using the Purchases Returns and Allowances account. Other approaches include:
- Creating a credit to the vendor’s account for the return and adjusting the Accounts Payable account accordingly.
- Recording the return in the Inventory account, if the items were returned before they were sold to customers.
- Reversing the original entry for the purchase and recording the return in the Cash account, if the items were paid for in cash.
- Recording the return in the Cost of Goods Sold account, if the items were returned after they were sold to customers.
In summary, Purchases Returns and Allowances is one approach to record purchases returns and allowances, but other approaches may be used depending on the circumstances.
| Purchase returns and allowances — recommended articles |
| Purchase account — Net purchases — Prepaid income — Purchases ledger — Purchase ledger — Operating cycle — FOB destination — Purchases journal — Trade receivables |
References
- Bienias Gilbertson C. (ed.)(2008),Century 21 Accounting, Cengage Learning, USA
- Heintz J. (ed.)(2007),College Accounting, Cengage Learning, USA
- Loughran M. (2011),Financial Accounting For Dummies, John Wiley & Sons, New Jersey
- Weygandt J. (ed.)(2009),Financial Accounting, John Wiley & Sons, New Jersey
Footnotes
Author: Sylwia Szrajber
