Accounting Test Part 1 Flashcards

The credit note is given by the supplier for the faulty goods and posted to the purchases allowance contra expense account; this reduces the net purchases of the business. Prepare Financial StatementsThe closing entries will be a review as the process for closing does not change for a merchandising company. Closing entries also set the balances of all temporary accounts to zero for the next period. You would debit accounts payable because you paid the bill, so the account decreases. Cash is credited because cash is an asset account that decreased because cash was used to pay the bill. It’s an asset account, so an increase is shown as a debit and an increase in the owner’s equity account shows as a credit. The balance of an account increases on the same side as the normal balance side.

• When we discussed discounts, we used Purchase Discounts.
• Most of the time in accounting, the account names describe what is going on.
• Sales returns are goods returned to the store for a refund; allowances are discounts on damaged items that the customer agrees to keep.
• Since we are now discussing returns and allowances, can you figure out what account we will use?
• Under periodic inventory, we do not use the Inventory account to record day-to-day transactions.
• Instead, we use Purchases and the contra accounts related to Purchases.

The value being returned to inventory is the cost that Whistling Flute paid for the inventory, which is $400. When a customer buys something for you, you record the transaction in your books by making a sales journal entry. So, when a customer returns something to you, you need to reverse these accounts through debits and credits. But if you don’t know how to account for a return with a purchase returns and allowances journal entry, your books will be inaccurate. Sales returns and allowances are not liabilities, which go on the balance sheet, nor can you simply reduce the amount of sales revenue in your ledgers to reflect returns.

The Normal Balance Of Sales Returns And Allowances Is A Credit A. True B. False

On your income statement, you subtract returns and allowances from gross sales to get net sales. Sales returns are goods returned to the store for a refund; allowances are discounts on damaged items that the customer agrees to keep. Under periodic inventory, we do not use the Inventory account to record day-to-day transactions. Instead, we use Purchases and the contra accounts related to Purchases.

This account is not classified as an asset since it does not represent a long term value. It is not classified as a liability since it does not constitute a future obligation. Under the perpetual inventory system, purchases of merchandise for sale are recorded in the Inventory account. We will take the difference between income summary in step 1 $275,150 and subtract the income summary balance in step 2 $268,050 to get the adjustment amount of $7,100. This should always match net income calculated on the income statement. We have 2 revenue accounts with a credit balance, Sales Revenue and Interest Revenue. Closing the revenue accounts with credit balances—transferring the credit balances in the revenue accounts to a clearing account called Income Summary.

Contra accounts are accounts that are related, yet separate from its particular account. A contra expense account will behave in the opposite way a normal expense account will; instead of debiting to increase, a contra account must credit to increase. Instead of crediting to decrease, it will be credited to increase. An example of a contra expense account is Purchase Returns and Allowances. A debit is an accounting entry that either increases an asset or expense account, or decreases a liability or equity account.

Purchases returns and allowances is a contra account to purchases. The debit to accounts payable reduces the amount Bill owes the supplier by the amount of the allowance. The credit to purchases returns and allowances reduces the value of the defective bikes in the purchases account. The income https://accounting-services.net/ statement account Sales Returns and Allowances is a contra revenue account that is associated with the revenue account Sales. If the balance in this contra account is a debit of $3,000 and the Sales account has the expected credit balance of $400,000, the company’s net sales are $397,000.

Exceptions to this list would be contra accounts such as Allowance for Doubtful Accounts and Accumulated Depreciation . In other words, credit balances are expected for contra asset accounts. Notice the entries for returns and allowances are the same for the buyer. We are not tracking physical quantities of inventory here.

Their balances will increase with a debit entry, and will decrease with a credit entry. Liabilities, revenues and sales, gains, and owner equity and stockholders’ equity accounts normally have credit balances. Sales allowances are not as vulnerable as sales returns to employees who might be inclined to fraudulent activity.

If your company issues $9,000 of the $39,000 as dividends, you reduce the assets and equity accordingly. If it was a mix of both, such as $4,000 on credit and $1,000 cash, you adjust both accounts as well as sales returns. For example, suppose returns and allowances normally total 2% of your sales revenue. It’s worth investigating bookkeeping why and seeing if the problem is solvable. Contra accounts are identified as asset accounts or revenue accounts even though they run in the negative. They exist to provide you and anyone reviewing your finances with extra information, as $150 in gross sales with $9 in returns is more informative than if you merely recorded $141.

A contra account’s natural balance is the opposite of the associated account. If a debit is the natural balance recorded in the related account, the contra cash basis account records a credit. In the financial statements the purchases account would be offset against the contra expense accounts to show the net purchases.

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But instead of entering in your Cash account, you credit your Accounts Payable account. records an allowance for sales returns and allowances as follows.

In both cases the dollar value of the inventory has changed, so the entry is the same. In this case a liability decreases as the amount owed to the supplier is reduced by the purchases allowance credit note, this reduction ledger account is balanced by the increase in owners equity. The credit to the income statement for the purchases allowance increases the net income which increases the retained earnings and therefore the owners equity in the business.

Why Are Contra Accounts Important?

That $39,000 becomes part of the assets on your balance sheet as either cash or accounts receivable. It becomes part of the owners’ equity as well as retained earnings.

At the end of the year, expense accounts need to be closed, or zeroed out. Expense accounts need to be closed because they are temporary, meaning that they pertain only to a given accounting period and won’t carry over into the next one. When expense accounts are closed, they close to another temporary account, known as Income Summary. So, the expense accounts must be credited, and the Income Summary will be debited.

Purchase Discounts and Purchase Returns and Allowances are expected to have credit balances. If a customer made a cash purchase, decrease the Cash account with a credit. This purchase allowance journal entry lowers your net sales. You don’t purchase return and allowances is a contra account and its normal balance would be report an allowance or purchase return on the balance sheet. Instead, you record them in your ledger and then put returns and allowances on the income statement. As they reduce your earnings, this will affect the balance sheet indirectly.

The contra equity account reduces the total number of outstanding shares. The treasury stock account is debited when a company buys back its shares from the open market. A liability that is recorded as a debit balance is used to decrease the balance of a liability. The balance of a contra liability account is a debit balance. Contra Liability a/c is not used as frequently as contra asset accounts.

This use of Sales Returns and Allowances enables management to see that its customers had a problem with $3,000 of the company’s goods. The debit or credit balance that would be expected in a specific account in the general ledger. For example, asset accounts and expense accounts normally have debit balances. Revenues, liabilities, and stockholders’ equity accounts normally have credit balances. Sales returns and sales allowances are different from temporary price reductions. While they all have the effect of reducing gross sales, temporary price reductions are treated differently.

It would appear on the company’s income statement in the revenue section. When a contra asset account is first recorded in a journal entry, the offset is to an expense. For example, an increase in the form of a credit to allowance for doubtful accounts is also recorded as a debit to increase bad debt expense. An allowance is a reduction in price granted by the seller to the buyer.

No matter how great your products are, you’re bound to have purchase returns at some point or another. There are times where an account will not have the normal balance if a correction is being made from a previous period. When purchase return and allowances is a contra account and its normal balance would be using the periodic method, the entries for allowances are the same as entries for returns because we do not track inventory under the periodic method. First, let’s look at this from the perspective of Medici Music, the buyer.

A credit is an accounting entry that either increases a liability or equity account, or decreases an asset or expense account. When a customer returns something they paid for with credit, your Accounts Receivable account decreases. Reverse the original journal entry by crediting your Accounts Receivable account. Although you don’t lose physical cash, you lose the amount you were going to receive. Rather than refunding a customer with cash, you might credit merchandise at your business. Accounting for a purchase return with store credit is similar to a cash refund.