Chapter 6.5® - Sales Returns & Allowances & Shrink (Merchandise Adjusting Journal Entries) - Continued from Accounting for Merchandise Sales– Perpetual Inventory System

• Part 6.1 - Accounting for Merchandising Activities, Balance Sheet Representation of Inventory, Perpetual & Periodic Inventory Systems & Merchandise Purchases
• Part 6.2 - Types of Merchandising Inventory Systems - Perpetual & Periodic Inventory Systems & Journal Entries for Merchandise Purchases – Perpetual Inventory System
• Part 6.3 - Transfer of Ownership, FOB Shipping & FOB Destination Points - Accounting for Transportation Costs of Merchandise Inventory
• Part 6.4 - Accounting for Merchandise Sales, Sales Discounts, Sales Returns & Allowances & Shrink – Perpetual Inventory System
• Part 6.5 - Sales Returns & Allowances & Shrink (Merchandise Adjusting Journal Entries) - Continued from Accounting for Merchandise Sales– Perpetual Inventory System
• Part 6.6 - Glossary of Merchandise Accounting Terms

Sales returns refers to merchandise that customers return back after a sale is completed due to a variety of reasons including defective merchandise, incorrect item, poor quality, wrong specifications, etc. Most companies allow customers to return merchandise for a full refund. Sales allowance on the other hand refers to reductions in the selling price of merchandise sold to customers and can happen in cases of damaged merchandise. Damaged merchandise can make customers very unhappy and in order to avoid future lost sales and customers, most companies offer an allowance (reduction in price) to the customer to keep the item.

As an example, consider Binti Kiziwi Corp. records a purchase of $1,500 Sony camera on credit on September 14th, 2009 and also sells this camera for $2,200 on September 27th, 2009 on credit on 2/10 n60 days terms. But what happens if the customer returns part of this merchandise on October 10th, 2009 and gets a $700 cash refund (original cost = $500). The revenue part of this transaction is recorded below:

Some companies prefer to record this return with a debit to the Sales account instead of Sales Returns and Allowances. This practice has the same effect but does not provide information to managers about sales returns and allowances. If the merchandise returned above is not defective and can be re-sold to another customer, Binti Kiziwi Corp. returns the goods to its inventory by debiting it, and crediting Cost of goods sold expense. Here is the journal entry in this scenario:

Another possibility that can happen is say the customer returns $700 worth of merchandise and the company allows him to pay it off for $500 and keep the merchandise, and thus not accept a return back. Here is the only journal entry that would be made:

Merchandise Adjusting Entries – Shrinkage

Merchandising companies using a perpetual inventory system are often required to make additional adjustments to their inventory by updating the merchandise inventory account to reflect any losses of merchandise including loss from theft, deterioration, loss in transit, loss in store, misplacement, etc; this is known as inventory shrinkage or “shrink” for short form. Using the perpetual system, we can compute shrinkage by doing a physical inventory count at given periods during the year and compare with accounting records of stated inventory balances. For instance, say Binti Kiziwi Corp. has merchandise inventory of $738,000 at the end of 2009 in its accounting books, but a physical inventory done in its warehouse says it only has $712,000 worth of merchandise remaining. Shrink in this case is computed as follows: