Product rebates are an incentive that induces customers to purchase a company’s goods. Accountants have the responsibility to properly record rebate transactions into the company’s general ledger. Companies that offer product rebates incur a liability, because customers who turn in rebates often expect to receive cash or gift cards worth a specific dollar amount.
Generally accepted accounting principles state that rebates are a reduction in sales, not a selling expense. Therefore, companies must account rebates when selling goods. For example, say a company sells widgets for $5 each, and a planned 20 percent rebate is coming to induce higher sales. If the company sells $100,000 in widgets after the rebate takes effect, it must record $80,000 in sales and $20,000 in liability for rebate claims in the general ledger.
Breakage represents the amount of rebates a company expects customers will not redeem. Unredeemed rebates are an increase to sales, because the company will earn this money when the rebate period expires. Companies estimate breakage prior to issuing a new product rebate. The common estimation method is to review previous rebate offers and compute a historical percentage of unredeemed rebates.
Journal Entry Examples
Rebate transactions have a few different journal entries. When selling goods that include rebates, accountants must debit accounts receivable or cash, credit sales for the net sales amount and credit liability for rebate claims. When a rebate comes in, the company must debit liability for rebate claims and credit accounts receivable or cash, depending on how the customer paid for the products. Once the rebates have expired, accountants debit the liability for rebate claims and credit sales to recognize the rebate’s actual breakage amount.
The liability for rebate claims appears on a company’s balance sheet. The account typically falls under current liabilities, because the company expects to pay out the rebate funds within the next 12 months. A disclosure may be necessary to explain the rebate process to financial statement users. The disclosures are an addendum to the balance sheet and contain descriptive information on how the company expects to operate the rebate program, including the estimated breakage amount.