Purchase Return in Accounting and Finance: A purchase return, also known as a return inwards or return of goods, occurs when a buyer returns merchandise previously purchased from a supplier. This may be due to defective goods, incorrect orders, or other valid reasons. In accounting, a purchase return is recorded to reflect the reduction in inventory and the corresponding decrease in accounts payable or increase in accounts receivable.
Importance of Purchase Return:
- Accurate financial records: Recording purchase returns helps businesses maintain accurate financial records by reflecting the actual inventory levels and the corresponding payable or receivable amounts.
- Cost management: Proper documentation of purchase returns helps businesses identify patterns, such as frequent returns of specific products, which may indicate issues with suppliers or internal processes.
- Tax implications: Purchase returns impact tax liabilities, as they reduce the cost of goods sold and thus the taxable income.
- Supplier relationships: Keeping track of purchase returns allows businesses to negotiate better terms with suppliers or consider alternative sources if a supplier’s products consistently require returns.
Types of Purchase Return:
- Damaged goods: When products received are damaged or defective.
- Wrong items: When incorrect or unordered items are delivered.
- Excess quantity: When more products are delivered than ordered.
- Quality issues: When products do not meet the expected quality standards.
Formula on Purchase Return: There is no specific formula for purchase return. However, you can calculate the purchase return ratio by dividing the total value of purchase returns by the total value of purchases during a specific period.
Examples of Purchase Return:
- A retailer receives a shipment of clothes with some damaged items. They return the damaged items to the supplier.
- An electronics store orders 10 laptops but receives 15. They return the excess 5 laptops to the supplier.
Issues and Limitations of Purchase Return:
- Time-consuming: Processing purchase returns can be time-consuming for businesses, impacting their efficiency.
- Financial impact: Frequent purchase returns can lead to financial losses due to reduced sales, restocking fees, or shipping costs.
- Supplier relations: Excessive returns can strain relationships between buyers and suppliers, potentially leading to severed ties or reduced credit terms.
Purchase Return Journal Entry: When recording a purchase return, businesses should debit the accounts payable (or credit accounts receivable if the supplier allows a refund) and credit the inventory account. This reflects the decrease in both inventory and the amount owed to the supplier. If the purchase was initially made on credit, the journal entry would look like this:
- Accounts Payable (Debit)
- Inventory (Credit)
Purchase Return: Debit or Credit? A purchase return is a debit to accounts payable (or a credit to accounts receivable if a refund is allowed) and a credit to inventory. This is because it reduces the amount owed to the supplier and decreases the value of inventory held by the business.