Sale of Inventory

After the purchasing of inventory, the next step of the company is to sale the goods. The amount a business enterprise generally earns from selling merchandise inventory which is termed as sales revenue or sales. Companies record sales revenues when it is earned, in accordance with the revenue recognition principle. Sales are generally made on credit or for cash. There are some business documents which provide the written confirmation of sales transaction. For example, cash register tapes provide evidence of cash sales and a sales invoice provides evidence for a credit sale. The original copy of the sales invoice is sent to the customer, and the seller keeps a copy for use in recording the sale. This invoice shows the date of sale, customer name, total sales price, and other relevant information.

During the selling process, sale also creates an expense; this is Cost of Goods Sold, as the seller gives up the asset Inventory. Cost of goods sold is the cost of its inventory that has been sold to customers held by the company. Cost of goods sold is the major expense of merchandisers. The seller basically makes two entries for each sale transaction. The seller increases debits cash or, if it is a credit sale then the seller increases debits accounts receivable, and also increases (credits) Sales for the invoice price of the goods in recording of first entry. The second entry the seller records the cost of the merchandise sold: The seller increases (debits) Cost of Goods Sold, and also decreases (credits) Merchandise Inventory for the cost of those goods. For this reason, the merchandise inventory account always shows the amount of inventory that on hand.

To exemplify credit sales transaction in details assumes, ABC Company records its October 2 sale of $5,000(merchandise cost $2000) to XYZ Company as follows:

October 2

Accounts Receivable………. 5000
Sales ………………………5000
(To record credit sale to XYZ company per invoice #100)

October 2
Cost of Goods Sold……….2000
Merchandise Inventory……… 2000
(To record cost of merchandise sold on invoice #100 to XYZ Company)

Merchandising companies sometimes use more than one sales account for making internal decision. For example, ABC Company decides to keep separate sales accounts for its sales of each product. If the companies will keep separate sales accounts for major product lines, then the companies can more closely monitor sales trends and respond more strategically to changes in sales patterns. If any company made sales on account then the ABC Company could experience one of them. For example, a sales return or a sales allowance or sales discount or freight out.

Sales Returns & Allowances:

The reverse side of purchase returns and allowances is recorded by the seller as sales returns and allowances. When the customers return goods to the seller then it is called sales return. Assume the ABC Company returned goods to the XYZ Company then the journal entry will be as follows:

October 5
Sales Returns and Allowances………… $500
Accounts Receivable…………… $500
(To record credit granted to XYZ Company for returned goods)

Accounts Receivable decreases as XYZ Company will not collect cash for the returned goods. XYZ Company will only receive the returned merchandise and updates inventory records.

XYZ Company must also decrease the Cost of Goods Sold as follows

October 5
Merchandise Inventory…………… $200
Cost of Goods Sold………….. $200
(To record cost of goods returned)

The above example is applicable for non defective goods but If XYZ Company returns goods because they are damaged or defective, then ABC Company’s entry to record Merchandise Inventory and Cost of Goods Sold should be for the expected value of the returned goods, rather than their cost.

Sales Allowances: if the buyer ABC Company grants a sales allowance to reduce the cash to be collected from the customer then it is called sales allowance. Assume XYZ Company grants a $100 sales allowance for damaged Goods. A sales allowance is recorded as follows:

October 10
Sales Returns and Allowances……. 150
Accounts Receivable………150
(To record sales allowance for damaged goods.)

There is no inventory entry for a sales allowance as the seller receives no returned goods from the customer.

After these posting these entries, Accounts Receivable will have a debit balance of $4650, as follows:

                                      Accounts receivable

October 2        5000 October 5     Return        200
October10    Allowance  150
BAL.                 4650

Sales Returns and Allowances are considered as a contra-revenue account to Sales. The normal balance of Sales Returns and Allowances is a debit balance. Companies use a contra account, instead of debiting Sales, to disclose in the accounts and in the income statement the amount of sales returns and allowances.

Sales Discounts

If the seller provide the customer a discount—for the prompt payment of the balance due then it is referred as sales discount. Or if the customer pays within the discount period—under some credit terms such as 3/15 n/30— ABC Company collects the discounted amount.  This discount is based on the invoice price if there any less returns and allowances then it be deducted. The seller increases (debits) the Sales Discounts account for discounts that are taken.

On October 15, the last day of the discount period, XYZ Company receives $3,000 of this receivable. Assume XYZ Company allows customers to take discounts on all amounts XYZ Company receives within the discount period. XYZ company’s cash receipt is $2910 [$3,000 _ ($3,000 × 0.03)], and the collection journal entry is as follows:

October 15

Cash . . . . . . . . . . . . . . . . . 2910
Sales Discounts ($4,000 × 0.02) . . . . .  90
Accounts Receivable. . . . . . . . . 3000
(To record cash collection within the discount period.)

Assume that XYZ Company collects the remaining $2,500 on July 28. There is no sales discount as the date falls after the discount period. XYZ Company records this collection on account as follows:

July 28
Cash ($4650-$3000) . . . . . . . . . . . . . . . 1650
Accounts Receivable. . . . . . . . . . . . .1650
(To record Cash collection after the discount period.)
This transaction will lead the balance 0 in the account of Accounts Receivable of XYZ Company:

                                     Accounts receivable

October 2        5000 October 5   Return        200
October10  Allowance 150
October15  Collection  3000
October10  Collection  1650
BAL.                 0

Like Sales Returns and Allowances, Sales Discounts is a contra-revenue account to Sales. And its normal balance is also a debit balance. XYZ Company uses this account, instead of debiting sales, to disclose the amount of cash discounts which is taken by customers.