What Is a Sales Allowance? (Definition and Examples)

Sales allowance refers to reduction in the selling price when a customer agrees to accept a defective unit instead of returning it to the seller. It is normally recorded under the account “Sales Returns and Allowances”.

A sales allowance is a reduction in the price charged by a seller, due to a problem with the sold product or service, such as a quality problem, a short shipment, or an incorrect price. Thus, the sales allowance is created after the initial billing to the buyer, but before the buyer pays the seller.

How to Account for Sales Returns and Allowances

Difference between a sales allowance and a sales return

The difference between a sales allowance and a sales return is the details of the transaction. In both, the customer may be unhappy with the product they receive, but with a sales allowance, the customer agrees to accept the item as-is in exchange for a price reduction. In contrast, a sales return would mean that the customer is unhappy with the product they purchase and does not want to keep it. Instead, they want to return the product for a full return of their money back.

What is a sales allowance?

A sales allowance is a price reduction that a seller initiates because of a problem with the buyers order. This can mean that the buyer received a defective product, didnt get part of their order or paid the incorrect price for an item, along with many other scenarios that a seller determines. A sales allowance is what a seller offers a buyer as an alternative to the buyer returning the product.

There are a couple of benefits to providing sales allowances to customers, including:

Better customer relationships

Many customers value doing business with a company that tries to fix their mistakes. There are many times when situations arent going to be perfect, but its what a company does about it that can make a difference to the customers they serve. If you are intentional with offering a price reduction, this appears as a good faith effort on your behalf and can please the customer.

Less money spent

It can cost money to accept a return on an item because you typically have to attempt to resell it, spend money to fix the item so its ready for purchase by somebody else or discard it and record the item as a larger loss.

Less time spent

If you have to process a sales return versus a sales allowance, it can take more time. With a sales allowance, you may discount an item or issue money back to a customer, both of which rarely take a lot of time for an employee to complete. However, a sales return may include arranging for product pickup from the customers home or issuing a return label and instructing the customer to take the action to return the item themselves, both solutions that typically have more logistics involved than a sales allowance would.

Ability to quality control

With proper accounting, youll keep records of any sales allowances, including the amount of the allowance and why you offered the allowance to your customer or vendor. Over time, you can identify trends in your allowances, possibly establishing that your company has shipping issues or a defective part of your production process. You can also identify which customers wanted to accept the sales allowance and which wanted to move forward with a return of the product.

Accounting for sales allowances

When you provide a sales allowance to a customer, you should list the transaction to maintain correct bookkeeping records. One of the first steps is making sure the financial records include a sales allowance account. This will help you identify where to place the amount of sales allowance for each customer who accepts the offer from your company.

Once you offer a sales allowance to the customer, you should record it right away to prevent any oversight in your record keeping. How you record the details depends on how the customer purchases the product. Usually, customers will either have an account with your company, which is typical in business-to-business (B2B) sales or will pay for their purchases through personal credit or cash, a common transaction type for business-to-consumer (B2C) companies.

No matter which way you receive payment from your customer, youll record the reduction in price as a debit under the “sales returns and allowances” account line. If the customer or vendor has an account that they use to purchase goods with, and used that account to buy the product youre providing a sales allowance for, you would also record your sales allowance amount as a credit under your “accounts receivable” account line. For any customer who purchases the product using cash, the sales allowance amount may also appear as a credit on the “cash” line in your financial records.

Your sales allowances account is called a contra-revenue account and youll record the amount in this account at the end of a reporting period on your income statement. You would later deduct these figures from your gross revenue of sales because sales allowances affect the companys net income. Youll also be better able to see which percentage of your sales are sales allowances that you have provided.

Examples of sales allowance scenarios

These examples of sales allowance scenarios can help you understand sales allowances more:

Example 1

Home Decor USA, a company that sells items to furnish homes, sells a four-pack of bar stools to a customer. The customer, after paying $100 per stool, assembling them and placing them at her kitchen countertop, discovers that two of the bar stools wobble.

The customer calls Home Decor USA to let them know of this issue and Home Decor USA then offers a sales allowance of $20 per bar stool thats uneven for a total of $40. Because the customer wants to keep the bar stools, she accepts. To process this, Home Decor USA refunds its customer for the $40 using the original method of payment.

Example 2

A customer is shopping at Anderson Grocers and wants to purchase five cans of black beans, but they realize the cans are significantly dented. The customer still wants to purchase the beans because they were the last cans on the shelf, so a manager at Anderson Grocers may provide a sales allowance to the customer.

The allowance would decrease the price of each can of black beans from $1.03 to $0.73, meaning the customer would owe $3.65 ($0.73 x 5) for their purchase instead of $5.15 ($1.03 x 5). The sales allowance is $1.50 because its the difference between what the cost of the groceries would have been and what they now are because of the price reduction.

Example 3

Paper Solutions Inc., a company that sells paper products to enterprise-level businesses, ships deposit slip paper to a large bank for use in the lobby of 20 different branches. However, the deposit slips Paper Solutions sends dont meet the exact specifications outlined in the agreement.

Paper Solutions Inc. can offer account credit to the bank, provided that the bank is okay with keeping the incorrect deposit slips. Instead of charging the bank $1,000 for the order, Paper Solutions may give them a $250 account credit, which would be the same amount of the sales allowance figure in the companys financial records.

FAQ

What is the difference between sales return and sales allowance?

A sales return occurs when a buyer sends a product back to a seller for a partial or full refund. An allowance is a retroactive discount a customer receives when they contact a company about a minor but noticeable defect with its product. Both are subtracted from a company’s gross sales to calculate net sales.

Is sales allowance an asset?

Sales Allowance and Returns: The Accounting

Discounts, allowances and returns are all contra accounts, included among asset accounts even though they represent losses.

Are sales allowances an expense?

Definition of Sales Discounts

Sales discounts (along with sales returns and allowances) are deducted from gross sales to arrive at the company’s net sales. Hence, the general ledger account Sales Discounts is a contra revenue account. Sales discounts are not reported as an expense.

Is sales allowance a revenue?

Therefore, sales returns and allowances is considered a contra‐revenue account, which normally has a debit balance.

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