What Are Returns & Allowances?

Return policies foster customer goodwill that leads to future sales.

In accounting, returns and allowances are aspects of sales transactions. In order to maintain customer relations, businesses allow for customers to return unsatisfactory merchandise and give discounts -- allowances -- in certain situations. Profit margins are affected by returns and allowances, but customer satisfaction leads to increased future sales.

Sales Returns

Sales associates process returns at the request of individual customers, usually due to merchandise defects. Each business has the freedom to choose its own return policy, which outlines how many days after purchase an item can be returned, in what condition the item must be for a refund and whether the original receipt is needed for processing. The condition of the item determines whether it goes back into inventory or is considered a loss.

Sales Allowances

Sales allowances are used to discount items in certain circumstances. Sometimes an item is slightly damaged but can still be sold at a discount, and sometimes a dissatisfied customer can be pacified with the offer of a percentage off the retail price of the item. In certain circumstances items may be discounted below cost, resulting in a net loss for the company; other times a discount may simply result in a reduced profit.

Customer Goodwill

Sales returns and discounts may lower a company's profit margin, but the goodwill extended to customers fosters brand loyalty that can actually increase customer retention and therefore profits in the long run. Each company must decide how liberally to extend such courtesies, a decision that is based upon initial profit margins. If a company is already only making a small percentage of profits per item, it may decide to employ a strict return or allowance policy.

Accounting for Returns and Allowances

Returned items that can be resold are returned to inventory by crediting the inventory account and debiting the cash account. Large businesses make one accounting entry for an entire day rather than recording each transaction individually. Each business budgets an amount for sales discounts each accounting period and creates a contra-revenue account to keep track of daily allowances. Each allowance or group of allowances are recorded by debiting the contra-revenue account and crediting the sales revenue account.

References

• "Financial and Managerial Accounting: The Basis for Business Decisions"; Jan Williams, Sue Haka, Mark Bettner, Joseph Carcello; 2010