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5.4: Seller Entries under Perpetual Inventory Method

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    26205
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    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:

    Name Account Type Increases Decreases
    Cash Current asset Debit Credit
    Accounts Receivable Current asset Debit Credit
    Merchandise Inventory Current asset Debit Credit
    Sales Revenue Revenue Credit Debit
    Sales Discounts* Revenue Debit Credit
    Sales Returns and Allowances* Revenue Debit Credit
    Cost of Goods Sold Expense Debit Credit
    Delivery Expense Expense Debit Credit

    *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:

    Date Account Debit Credit
    May 4 Accounts Receivable 30,000
    Sales Revenue 30,000
    To record sale of merchandise on credit
    May 4 Cost of goods sold 18,000
    Merchandise Inventory 18,000
    To record cost of merchandise sold to customers.
    May 21 Cash 20,000
    Sales Revenue 20,000
    To record sale of merchandise for cash.
    May 21 Cost of goods sold 15,000
    Merchandise Inventory 15,000
    To record cost of merchandise sold to customers.

    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:

    Date Account Debit Credit
    May 4 Delivery Expense 100
    Cash 100
    To record shipping costs for sales.

    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:
    Account Debit Credit
    Sales Returns and Allowances 400
    Accounts Receivable 400
    To record sales allowance granted to a customer.

    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:

    Account Debit Credit
    Sales Returns and Allowances 400
    Sales Discounts (400 x 2%) 8
    Cash (400 – 8) 392
    To record sales allowance refund to customer less discount.
    • 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:
    Account Debit Credit
    Sales Returns and Allowances 300
    Accounts Receivable 300
    To record customer return on credit sale.
    Merchandise Inventory 200
    Cost of goods sold 200
    To record receipt of returned merchandise.

    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):

    Account Debit Credit
    Sales Returns and Allowances 300
    Sales Discounts (400 x 2%) 6
    Accounts Receivable 294
    To record customer refund with 2% discount.
    Merchandise Inventory 200
    Cost of goods sold 200
    To record receipt of returned merchandise.

    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:

    Date Account Debit Credit
    May 10 Sales Discounts (30,000 x 2%) 600
    Cash (30,000 – 600) 29,400
    Accounts Receivable 30,000
    To record customer payment with 2% discount.

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

    Account Debit Credit
    Sales Discounts (29,700 x 2%) 594
    Cash (29,700 – 594) 29,106
    Accounts Receivable 29,700
    To record customer payment with 2% discount and return.

    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:

    Date Account Debit Credit
    May 30 Cash (30,000 – 400) 29,600
    Accounts Receivable (30,000 – 400) 29,600
    To record customer payment less allowance and no discount.

    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.

    A Open Assessments element has been excluded from this version of the text. You can view it online here: pb.libretexts.org/llfinancialaccounting/?p=112

    CC licensed content, Shared previously
    • Accounting Principles: A Business Perspective. Authored by: James Don Edwards, University of Georgia & Roger H. Hermanson, Georgia State University. Provided by: Endeavour International Corporation. Project: The Global Text Project . License: CC BY: Attribution
    All rights reserved content
    • Sales Journal Entries under the Perpetual Inventory Method. Authored by: Note Pirate. Located at: https://youtu.be/F-HQgC0Dw1g. License: All Rights Reserved. License Terms: Standard YouTube License

    5.4: Seller Entries under Perpetual Inventory Method is shared under a CC BY license and was authored, remixed, and/or curated by LibreTexts.

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