Purchase Return

A purchase return is a transaction in which a buyer returns goods it has bought to the supplier, usually because they are damaged, defective, of the wrong type or quantity, delivered late, or not as ordered. The return reduces the cost of the buyer's purchases and either reduces the amount it owes the supplier or entitles it to a refund. When the buyer keeps the goods but receives a price reduction instead, the transaction is a purchase allowance; the two are often recorded together in a purchase returns and allowances account.

For the supplier, the same transaction is a sales return. The buyer usually documents the return by issuing a debit memorandum to the supplier, so called because it debits (reduces) the supplier's account in the buyer's books, while the supplier issues a credit memo confirming the reduction in the amount due.

The entry depends on the inventory system:

• Perpetual system: the buyer debits accounts payable (or a receivable from the supplier, if the invoice was already paid) and credits inventory for the cost of the goods returned, so inventory records stay accurate.
• Periodic system: the buyer debits accounts payable and credits purchase returns and allowances, a contra account to purchases. At period end, the balance is subtracted from purchases in calculating cost of goods sold.

If the original purchase was recorded net of an expected early payment discount, or if part of a discount has already been taken, the return is recorded at the same net amount so that the discount is not over- or under-stated.

On 5 June, a clothing retailer buys 400 jackets at $30 each, $12,000 in total, on credit with terms of 2/10, net 30. On 8 June it finds that 50 jackets have faulty zips and returns them, sending a debit memorandum for $1,500. Using a perpetual system, it records:

• 5 June: debit inventory $12,000; credit accounts payable $12,000.
• 8 June: debit accounts payable $1,500; credit inventory $1,500.

The amount owed falls to $10,500. If the retailer pays within the discount period, the discount applies only to the net amount owed:

Here $\text{Invoice}$ is the original amount billed, $\text{Returns}$ is the value of goods sent back and $d$ is the discount rate. Cash paid is $10,500 times 0.98, or $10,290, and the discount is $210. Under a periodic system, the 8 June entry would credit purchase returns and allowances instead of inventory, and the year's cost of goods sold calculation would start with purchases of $12,000 less returns of $1,500.

Keeping purchase returns in a separate account under the periodic system, rather than simply reducing purchases, gives managers information about supplier quality and ordering accuracy. A high level of returns may indicate unreliable suppliers, poor specifications or errors in purchasing, each of which carries hidden costs such as staff time, shipping, and lost sales from stockouts. Freight costs on returns are usually borne by whichever party is at fault under the contract; if the buyer pays to ship goods back, the cost is generally an expense rather than an addition to inventory, unlike freight-in on goods kept.

Accountants also check cut-off at period end: goods returned just before the year end should be removed from inventory and payables in that period, while returns that are only being negotiated should not be recorded until agreed. Returns also feed into the calculation of the cost of goods purchased and the cost of goods available for sale. Where suppliers refuse a return, the buyer may need to write down the faulty goods to their net realizable value instead, and the timing of any refund affects the related journal entry and cash flow.