The accounting is very different for sellers than for buyers.  Remember, under the perpetual inventory method, we used a combination of 3 accounts (Cash, Inventory and Accounts Payable) on the buyer side.  This is not the case for the seller.  The seller will use the following accounts:

*Sales discounts and sales returns and allowances are contra-accounts.  Notice how they increase with a debit and decrease with a credit even though they are revenue accounts.

Cost of goods sold

Cost of goods sold is exactly what the account name reads:  it is the cost of the goods merchandise inventory) to the seller that is now being sold to customers.  Cost of goods sold is not the price charged to customers but what a company paid for the goods they are now selling.  Cost of Goods Sold is an EXPENSE item. Even though we do not see the word Expense this in fact is an expense item found on the Income Statement as a reduction to Revenue.    Watch this video on seller entries before we look at them in more detail.

Recording Sales

Sales are recorded in a Sales Revenue (or Sales) account and is the price we charge to the customers.  Sales can be cash or have credit terms (on account) using Accounts Receivable since we will receive money from the customer in the future.  To record sales, we will debit Cash or Accounts Receivable, depending on payment, and credit Sales Revenue.

But, we must also match the revenue and expenses incurred (remember the matching principle?) and we will record the expense cost of goods sold.  Remember, cost of goods sold is the seller’s cost for the items they are now selling to a customer and is NOT the selling price.  We begin learning this concept by having cost of goods sold amounts provided but in a later section, you will learn to calculate the amount yourself.  We will debit the expense Cost of Goods Sold but what was it we were selling?  Right!  Merchandise or merchandise inventory so we will reduce (credit) merchandise inventory since we no longer have the goods.

To illustrate the perpetual inventory method journal entries, assume that Smith Company made two sales of merchandise to Hanlon Food Store:

• On May 4, Smith sold $30,000 of merchandise with credit terms of 2/10, n30 and shipping terms FOB Destination.  The original cost to Smith was $18,000.
• on May 21, Smith sold $20,000 of merchandise for cash with shipping terms FOB Shipping Point.  The original cost to Smith was $15,000.

The journal entries to record the sale and cost of goods sold for each date would be:

Notice how each transaction has 2 entries.  One to record the sale to the customer and one to record the usage of inventory as a cost of goods sold.

Shipping on Sales

We learned shipping terms tells you who is responsible for paying for shipping.  FOB Destination means the seller is responsible for paying shipping and the buyer would not need to pay or record anything for shipping.  FOB Shipping Point means the buyer is responsible for shipping and must pay and record for shipping.  As the seller, we will record any shipping costs in the Delivery Expense account as a debit.  We will credit cash or accounts payable, depending on if we paid it or not.

In our two transactions above, the May 4 sale has shipping terms of FOB Destination so the seller would pay for shipping.  In the May 21 sale, the shipping terms FOB Shipping Point means the buyer is responsible and the seller will not record anything for shipping.

Smith Company paid $100 cash on May 4 for shipping on the May 4 sale to Hanlon Food Store.  The journal entry to record this transaction would be:

Sales Returns and Allowances

Merchandising companies usually allow customers to return goods that are defective or unsatisfactory for a variety of reasons, such as wrong color, wrong size, wrong style, wrong amounts, or inferior quality.  A sales return is merchandise returned by a buyer. A sales allowance is a deduction from the original invoiced sales price granted when the customer keeps the merchandise but is dissatisfied for any of a number of reasons, including inferior quality, damage, or deterioration in transit.

When a seller agrees to the sales return or sales allowance, the seller sends the buyer a credit memorandum indicating a reduction (crediting) of the buyer’s account receivable. A credit memorandum becomes the basis for recording a sales return or a sales allowance.

In theory, sellers could record both sales returns and sales allowances as debits to the Sales account because they cancel part of the recorded selling price.  However, because the amount of sales returns and sales allowances is useful information to management, it should be shown separately. The amount of returns and allowances in relation to goods sold can indicate the quality of the goods (high-return percentage, equals low quality) or of pressure applied by salespersons (high-return percentage, equals high-pressure sales).

Sellers record sales returns and sales allowances in a separate Sales Returns and Allowances account. The Sales Returns and Allowances account is a contra revenue account (to Sales) that records the selling price of merchandise returned by buyers or reductions in selling prices granted.

The accounting method will be different for a sales return and an allowance.  In a sales allowance, the customer is not returning any merchandise and we will only adjust the customer side of the transactions (sales and accounts receivable).  In a sales return, the customer is actually returning merchandise.  We will need to reduce the customer side (sales and accounts receivable) and increase the inventory side (inventory and cost of goods sold).  The inventory is returned to the seller which means we need to add it back to inventory and remove the expense since it is no longer sold.

Following are two examples illustrating the recording of sales returns in the Sales Returns and Allowances account:

• Assume that a company grants a $ 400 allowance to a customer for damage resulting from improperly packed merchandise. If the customer has not yet paid the account, the required entry would be:

If the customer has already paid the account, the credit is to Cash instead of Accounts Receivable. If the customer took a 2% discount when paying the account, the refund entry would be:

• Assume instead that a customer returns $300 of goods sold on account.  The goods cost the seller $200. Remember, a return requires 2 entries — one for the sales side and one for the inventory side.  If payment has not yet been received, the required entry is:

If the customer has already paid the account, the credit is to Cash instead of Accounts Receivable. If the customer took a 2% discount when paying the account, the refund entry would be (note: there would be no change to the inventory entry):

 Receiving Payment from Customers

Remember, the credit terms (or terms) provides information to the buyer about when the invoice is due and if there is a discount allowed for paying the invoice early.  The discount is not recorded until payment is received because the seller does not know if a buyer will take the discount or not.  Discounts are recorded in a contra-revenue account called Sales Discounts.  Receiving payment will affect the customer side only and not inventory.  We will be reducing the amount owed by the customer (accounts receivable) and increasing sales discounts (if any) and cash.

For example, Smith Company receives payment of the May 4 invoice from Hanlon Food Store on May 10.  The customer took the 2% discount.  The entry to record this transaction would be:

If Hanlon had returned merchandise for $300 before paying the invoice, the entry to record this transaction with a 2% discount would be:

Note:  This entry is the same with a sales return or a sales allowance.

If Hanlon had a $400 allowance but paid the invoice after the discount period on May 30, the entry to record the transaction (less the allowance) would be:

Summary

Cost of goods sold is not the price charged to customers but what a company paid for the goods they are now selling.  Cost of Goods Sold is an EXPENSE item.   Sales Discounts and Sales Returns and Allowances are contra-revenue accounts meaning they are REVENUE accounts but debits will increase and credits will decrease.

Sales revenue and sales return entries require 2 entries:  one for the customer side (accounts receivable and sales) and one for the inventory side (cost of goods sold and inventory).  Sales allowances require only the customer side.