In simple words, purchase returns which is also called “return outwards” is a situation whereby a buyer sends goods back to the supplier for various reasons which may be charged or free if the company offers free returns within a certain number of days of purchase.
However, having numerous products returned to the supplier can pose a setback to the profitability of the business. When there is a purchase return, a debit note is given to the seller, which literally means a reduction in receivables, and the goods returned are later recorded in General Ledger under the purchase returns account.
Reasons Customers Make Purchase Returns
There are quite a number of reasons why a buyer might return goods purchased to the supplier. Some of these are explained below:
- Damaged Goods: It is common for goods to be damaged while being transported to the buyer, particularly if the goods are fragile. It could also get damaged in the seller’s stores without being noticed. The buyer can, for this reason, decide to have the goods returned.
- Wrong Goods: If a supplier sends the buyer the wrong goods, either one or all of them, the buyer can make a purchase return.
- Wrong Order: If the goods ordered are not the goods required, the buyer may return them to the supplier. Here, the buyer can ask that the supplier replace them with the ones needed.
- Product Complexity: Goods can be returned to the supplier if they are too difficult to use or understand.
- Excessive Quantity: When the supplier’s goods exceed the amount required by the buyer, they can be returned.
- Inferior Goods: If the goods supplied are discovered to be of lower quality than what was requested, the buyer may request that they be returned to the company.
- Out Of Date/Time: Goods delivered when they are no longer needed can be returned. That is, when a company makes a late delivery and the buyer no longer needs it, it can be returned.
- Wrong Color: Suppliers might make the mistake of sending goods of a particular color that was not requested by the buyer, in a case like this, the buyer might have the goods returned in order not to incur a loss.
Is Purchase Return An Asset Or An Expense?
A purchase return account is also known as a nominal account, or better still, a contra-expense account, seeing that it brings about a reduction in the amount of purchase. It, therefore, cannot have a debit balance; rather, the balance will either be credit or zero. Remember that the purpose of accounting for purchase returns is to make the book of account appear as if there had been no purchase.
Meanwhile, purchases are naturally meant to have a debit balance since they are an addition to the inventory, which is an asset.
Is Purchase Returns Debit Or Credit?
In order to have a balanced account, the credit balance will be offset by the debit balance in the purchase account. This translates to having the purchase account credited when goods are returned, just as how the purchase account is debited when goods are bought from a supplier.
Recording purchase returns in accounting by a buyer can either be a credit to its inventory account or to a purchase account, and the offsetting debit is to the payable account. The de-escalation of purchase value can be recorded against an earlier purchase transaction with the use of a debit note. Also, the escalation of purchase value can be recorded using the voucher mode of a credit note.
Authorization And Return Outwards Fee
However, if a seller initially sends the wrong goods to the buyer, he can charge a restocking fee to the buyer before agreeing to accept a purchase return. The restocking fee is usually about 15% of the amount paid by the buyer for the goods being returned. But, if a company offers free returns on goods purchased within a certain period of time, the buyer will not be charged a restocking fee.
Note that purchase returns are mostly authorized under a Return Merchandise Authorization (RMA) that is given to the buyer by the seller, and when the buyer has a reason to return the goods to the seller, the RMA number, which is usually on the package, is marked. The department in charge of receiving the goods returns them and compares them with the RMA numbers in the purchase book before accepting the goods. If there is no RMA or the numbers do not match, the goods will be rejected.
Examples Of Purchase Returns
In the purchase returns journal entry, there is a need to debit accounts payable and credit purchase returns. This is due to the fact that, during the purchase of goods, the business incurs a liability that is recorded in the accounts payable. Debiting accounts payable leads to a reduction in liability, while crediting purchase returns is an indication that there is a decrease in expense.
There are two examples of purchase returns, and they are “credit purchases” and “cash purchases.”
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Purchase Returns for Credit Purchase
If company A purchased an engine at the rate of $5000 from company Z on credit, and have it returned due to its complexity. The record of the original transaction will be in the format below:
Debit Purchases $5000
Credit Company Z $5000
While the journal entry for purchase returns will be:
Debit – Account Payable (Company Z) $5000
Credit – Purchase Returns $5000
Note that all balances in the returned outwards need to be settled off and not transferred to the next year.
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Example of purchase returns for cash purchase:
When company A purchases an electrical appliance for $1000 from company Z, but later returns it due to color, the original transaction will be recorded as:
Debit Purchases $1000
Credit Cash $1000
Once the product is returned, it will be:
Debit Company Z (Receivable) $1000
Credit Purchases Return $1000
Purchase Returns In Income Statement (Trading Account)
The purpose of creating an income statement is to certify the gross profit of a business in a given period. The purchase return is then deducted from the total purchase to arrive at the net purchase. The record is kept on the debit side of the income statement. On the income statement, the purchase returns and allowances account are subtracted from the purchases.
For example, a company that deals with the sales of solar generators gets five generators from its regular supplier at the rate of $500 per one. The company returned two of the generators due to damage.
The total purchase made by the company is 5 × $500 = $2500
The return inwards (sales return) for that time is $500. To obtain the net purchase, $500 is subtracted from $2500, which then gives $2000.
Summarily, purchase returns refer to goods returned by the buyer to the suppliers for legitimate reasons.