CSLB Law & Business ExamBusiness FinancesHard
A contractor is reviewing the company's financial records and notes an entry where a customer's account balance was reduced because the customer returned defective goods. How should this transaction be recorded?
- ADebit Cash, Credit Sales Returns and Allowances
- BDebit Accounts Receivable, Credit Sales Revenue
- CDebit Sales Returns and Allowances, Credit Accounts Receivable
- DDebit Sales Revenue, Credit Accounts Receivable
Show answer & explanationAnswer & explanation
Correct answer: C. Debit Sales Returns and Allowances, Credit Accounts Receivable
When a customer returns goods, the company's revenue is effectively reduced, and the customer no longer owes money for those goods. This is recorded by debiting a contra-revenue account called 'Sales Returns and Allowances' to reduce net sales, and crediting 'Accounts Receivable' to reduce the amount the customer owes.
Why the other options are wrong
- A. This would imply cash was received, and Sales Returns was a liability, which is incorrect.
- B. This entry would increase Accounts Receivable and decrease Sales Revenue, which is incorrect.
- D. Debiting Sales Revenue directly is less common; a contra-revenue account is preferred.
Sales Returns and Allowances
A contra-revenue account used to record reductions in sales revenue due to customers returning merchandise or being granted allowances for defective goods.
- Has a normal debit balance, which reduces overall net sales.
- Used to track the amount of sales that are not realized due to customer dissatisfaction.
- Part of the sales revenue recognition process in accrual accounting.
Memory trick: Returns & Allowances DEBIT, to reduce the customer's AR.