Purchase Returns, also known as return outwards is a process where goods bought are returned to the supplier for being defected or damaged, different colour type, complex products, goods not ordered, late delivery, etc. Later in this article, i will explain the reasons for purchase returns.
Hence, the supplier will collect those goods back and make the subsequent adjustment entry in their accounts and ledgers to make sure that they maximize the entirely returns. A debit note is issued to the seller by the buyer when there is a purchase return and this is an indication of a reduction in receivables. For purchase returns, it means that goods are returned to the supplier, and will be recorded later in General Ledger under Purchase Returns account.
In the books, the purchase returns account often have a credit balance. Hence, in the purchase account, the credit balance will be offset by the debit balance. This means that since purchases are recorded on the debit side, then the returns will be recorded on the credit side so the account can be balanced.
Purchase Returns Account is a nominal accounts, it is also referred to as contra-expense account since it reduces the amount of purchases; hence, there is no way that it can have a debit balance. The balance of the return outwards will either be credit, or zero.
The main objective of purchase returns or return outwards accounting is to prepare the books of account in such a way that no purchase originally happened. Hence, the total amount of goods returned is substantially deducted from the purchases made.
For this reason, it is necessary to approach the overall system one step at a time, as opposed to making sure that the whole reversal has been done and the complete impact of the purchase has been reduced to the highest extent.
The most significant factor for not deducting it directly from purchases is to keep the accounting books clean, just in case of periodic auditing and internal controls.
Reasons for Purchase Returns or Return Outwards
There are various reasons why customers return goods to the supplier after buying them. We will explain a few;
1. Damaged or defected goods
Somethings, products get damaged before they get to their destinations. Some might get damaged on transit, either by accident or other causes. While others get damaged in the seller's store without prior notice. In this case, the buyer might decide to return the goods to the supplier.
2. Different Colour
In the case of different colour, a customer may order for a specific colour of a goods and another colour will be delivered by the supplier in error. For instant, a store owner ordered for white shoes, on receiving the shoes, he discovered that it came with black colour.
The store owner decided to return the shoes to the supplier since he couldn't deliver to the customer who needed it.
3. Goods not ordered
When a product is not ordered can lead to return outwards. For instance, when a buyer order for some goods, on receiving it, he discovered that there is a particular goods he didn't order for. As a result of this, he returns it to the supplier.
4. Late delivery
This happens when a product is delivered late after it is no longer in use. For instance, A man ordered a particular type of clothe to be worn to a wedding party, he didn't receive the clothe until three days after the party. So he decided to return the clothe to the supplier since he no longer needs it.
5. Complexity of a product
The complexity of a particular product can make a customer return it after purchase. For instance, you ordered for some electronics, then you discovered that they are very difficult to use. Hence, you returned it back to the seller who in turn returns it to the supplier so he can change it to an easier one.
Purchase Returns Journal Entry
Firstly, it is necessary to debit accounts payable, and credit purchase returns. This is so because accounts payable is a liability which the business incurred during purchase of goods and services. So, debiting accounts payable is a reduction in liability, while crediting purchase returns shows that there is a decrease in expense.
On another note, it was also an anticipated cost that probably would be incurred, as a result of making payments for the goods and services that the company purchased.
The Journal Entry for Purchase Returns or return outwards
Debit – Account Payable (decrease in liability)
Credit – Purchases Returns (decrease in expense)
The accounting treatment shown above is mostly for situations where the purchases was done on credit.
However, if the purchases was on cash basis, it should be noted that cash would apparently be debited (since the company received cash, against the returned goods that was bought), and Purchases Return will be credited (since it decreases the amount of expense due for the company).
Purchase Returns Example For Credit Purchases
For instance, ABC Limited purchased a car for $1500 from XYZ Limited on credit. Then returned the car due to faulty brake.
The original transaction will be recorded as
Debit Purchases $1500
Credit XYZ Limited $1500
In this case, the journal entry for purchase returns will be recorded as:
Debit – Account Payable (XYZ Limited) $1500
Credit – Purchase Returns $1500
No further transactions should be done since the accounts have been set-off.
At the end of the year, all balances in the return outwards account are settled off, and should not be carried to the following year.
Purchase Returns Example For Cash Purchases
For instance, ABC Limited purchased a car for $1500 from XYZ Limited on cash. Then returned the car due to faulty brake.
The original purchase will look like this;
Debit Purchases $1500
Credit Cash $1500
After returning, the following accounts will be prepared
Debit XYZ Limited (Receivable) $1500
Credit Purchases Return $1500
What Happens To Cost Incurred During The Process Of Purchase?
In some companies, for transactions like purchases to happen, they have to incur some costs like administration cost (order), transportation cost i.e carriage inwards, etc.
When the goods are returned to the supplier, these costs which were incurred at the time of the original transaction may go waste. Extra costs like transportation, packing cost etc., are incurred in relation to the return transactions. These additional cost is a waste as it doesn't benefit both the buyer and supplier.
The possibilities of such transactions are almost inevitable, they are natural and acceptable. The main thing is to reduce the chances of returns.
Excess Purchase returns
These indicate that;
- A company purchased goods which do not meet its requirements.
- Poor quality of goods were purchased
- The supplier sold goods without properly inspecting the quality.
It may result in;
Disturbance in the organisational supply schedule which may lead to the company losing its valuable customers.
Treatment Of Purchase Returns In Trial balance
In the trial balance, all assets and expenditures are recorded on the debit side while all liabilities and incomes are recorded on the credit card. Purchases are recorded on the debit side to show an increase in inventories. Hence, purchase returns are recorded on the credit side of trial balance to have an offset.
Treatment Of Purchase Returns In trading account (Income Statement)
The main motive of preparing a trading account is to ascertain the gross profit of a business in a period. Purchase returns which is also called return outwards is deducted from the total purchases to arrive at the net purchases. It is recorded on the debit side of the trading account.
Example; Mr Solomon is a dealer of HD television, he usually buy goods from the manufacturer. One day, he bought 3 television sets at $100 each. He returned 1 television due to wrong colour type.
Total purchases is 3 × $100 = $300
The return inwards for the period is $100. To get the net purchases, we subtract $100 from $300 = $200.
Advantages of Purchase Return Journal Entry
The advantages of return outwards journal entry are:
- It helps a business to record all transactions involving return of goods that were purchased either in cash or credit from its supplier, thereby keeping track of records.
- When a business is recording purchases returns, it will reduce the balance of such transactions from the total inventory to ascertain the status of the current inventory at a particular time.
Disadvantages of Purchase Returns Journal Entry
Below are the disadvantages of return outwards journal entry:
The purchase Returns journal entry is done by a human, so chances are that the person responsible for recording such transaction might make mistakes in the process of recording, which will create a wrong view of the company.
In situations where a company has a great number of returns, recording every entry becomes time-consuming and difficult.
Therefore, in summary, Purchase Returns is an accounting concept which explains goods returned to their supplier as a result of of legitimate issues. The journal entry to return outwards is to Debit accounts payable, and credit return outwards.