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Under normal course of business, goods sold to customers is treated as sale immediately when the goods are sold, with corresponding revenue from such sale being recognized in the profit and loss account. However, when a businessman wants to increase his sales or introduce a new product in the market, he usually faces hardship due to competition prevailing in the market. To counter it, goods are sometimes sent to the customers on sale or return basis. Here, goods sent on ‘approval’ or ‘on return’ basis means goods are delivered to the customers with the option to retain or return them within a specified period. Generally, these transactions take place between a manufacturer (or a wholesaler) and a retailer. In current scenario, this practice is prevalent in case of online sales, where the buyer is given time of few days to return the goods if the buyer believes that the specifications of goods are different from the same mentioned on website at the time of sale. There may be certain terms and conditions to administrate the return of goods. Following are essentially the features of sale of goods on approval or return basis:
(a) There is a change in the possession of goods from one person to another.
(b) It does not involve transfer of ownership of goods. The ownership is passed only when the buyer gives his approval or if the goods are not returned within that specified period.
(c) The customer does not incur any liability when the goods are merely sent to him. In case of online transactions, sometimes customers are given choice to pay on receipt of goods and in some cases they are required to pay in advance and then seller ships the goods to buyer. Even in case the buyer has paid in advance, it retains the right of refund if the goods are returned as per the terms and conditions agreed between seller and buyer.
As per the definition given under the Sale of Goods Act, 1930, in respect of such goods, the sale will take place or the property in the goods pass to the buyer:
(i) When he signifies his approval or acceptance to the seller;
(ii) When he does some act adopting the transaction;
(iii) If he does not signify his approval or acceptance to the seller but retains the goods without giving notice of rejection, on the expiry of the specified time (if a time has been fixed) or on the expiry of a reasonable time (if no time has been fixed).
2.2 ACCOUNTING RECORDS
Accounting entries depend on the fact whether the business sends goods on sale or return basis (i) casually; (ii) frequently; and (iii) numerously.
2.2.1 WHEN THE BUSINESS SENDS GOODS CASUALLY ON SALE OR RETURN BASIS
When the transactions are few, the seller on sending the goods, treats them as an ordinary sale. If the goods are accepted or not returned or the business receives no intimation within the specified time limit, no extra entry is required to be passed because the entry for sale (passed at the time of sending goods) becomes the usual entry after the expiry of the specified period. If the goods are returned within a specified time limit, a reverse entry is passed to cancel the previous transaction. If, at the year-end, goods are still lying with the customers and the specified time limit is yet to expire, the entry for sales made earlier is cancelled and the value of the goods lying with the customers must be reduced from the selling price to the cost price, and treated as ordinary Inventories for Balance Sheet purposes.
(ii) These goods should be considered as Inventories with customers and in addition to the above, the following adjustment entry is to be passed:
CE records sale or return transactions as ordinary sales. You are required to pass the necessary Journal Entries in the books of CE assuming that accounting year closes on 31st December, 2016.
Note: (1) Alternatively, Sales account can be debited in place of Return Inwards account.
(2) No entry is required for receiving letter of approval from customer.
S. Ltd. sends out its goods to dealers on Sale or Return basis. All such transactions are, however, treated as actual sales and are passed through the Day Book. Just before the end of the accounting year on 31.03.2016, 200 such goods have been sent to a dealer at ₹250 each (cost ₹200 each) on sale or return basis and debited to his account. Of these goods, on 31.03.2016, 50 were returned and 70 were sold while for the other goods, date of return has not yet expired.
Pass necessary adjustment entries on 31.03.2016.
Note: (1) Quantity of goods lying with dealer as on 31.3.2016 = 200 – 50 – 70 = 80
Caly Company sends out its gas containers to dealers on Sale or Return basis. All such transactions are, however, treated as actual sales and are passed through the Day Book. Just before the end of the financial year, 100 gas containers, which cost them ₹ 900 each have been sent to the dealer on ‘sale or return basis’ and have been debited to his account at ₹1,200 each. Out of this only 20 gas containers are sold at ₹1,500 each.
You are required to pass necessary adjustment entries for the purpose of Profit and Loss Account and Balance Sheet.
E Ltd. sends out its accounting machines costing ₹ 200 each to their customers on Sales or Return basis. All such transactions are, however, treated like actual sales and are passed through the Day Book. Just before the end of the financial year, i.e., on March 24, 2016, 300 such accounting machines were sent out at an invoice price of ₹ 280 each, out of which only 90 accounting machines are accepted by the customers ₹ 250 each and as to the rest no report is forthcoming. Show the Journal Entries in the books of the company for the purpose of preparing Final Accounts for the year ended March 31, 2016.
A sends out goods on approval to few customers and includes the same in the Sales Account. On 31.3.2016, the Trade receivables balance stood at ₹1,00,000 which included ₹7,000 goods sent on approval against which no intimation was received during the year. These goods were sent out at 25% over and above cost price and were sent to–
Mr. X - ₹4,000 and Mr. Y - ₹ 3,000.
Mr. X sent intimation of acceptance on 30th April and Mr. Y returned the goods on 10th April, 2016.
Make the adjustment entries and show how these items will appear in the Balance Sheet on 31st March, 2016. Show also the entries to be made during April, 2016. Value of closing Inventories as on 31st March, 2016 was ₹60,000.
(1) Cost of goods lying with customers = 100/125 x ₹ 7,000 = ₹ 5,600
(2) No entry is required on 10th April, 2016 for goods returned by Mr. Y. Goods should be included physically in the Inventories-in-trade.
2.2.2 WHEN THE BUSINESS SENDS GOODS FREQUENTLY ON SALE OR RETURN BASIS
When a business sends goods on sale or return on a frequent basis, an immediate sale does not take place. Only when the customer signifies his intention to purchase the goods or takes some action whereby it is indicated that he has decided to purchase the goods, the property in the goods passes to the buyer. So long as the property does not pass to the buyer, the seller does not record it as a sale and, therefore, does not debit the customer with the sales price.
Under this method, record of goods sent is maintained in a specially ruled Sale or Return Journal / Day Book instead of passing entry for sale of goods. This Day Book is divided into 4 main columns - (1) Goods sent on Approval; (2) Goods Returned: (3) Goods Approved; and (4) Balance.
When such a Journal is kept the following procedure is adopted for recording transactions entered into on this basis:
When goods are sent out for sale on approval, entries are made only in column 1 to 4, the sale price of goods being entered in column 4. The sale price is also posted to the debit of the customers’ account in ‘Goods on Approval Ledger’, and periodically total of column 4 is posted to the credit of Goods on Approval Total Account in the same ledger.
If goods are returned, entries are made in columns 5 to 8, the price of goods returned being entered to column 8. The individual amounts are credited to the Customers’ Accounts, in the ‘Goods on Approval’ Ledger and the total of this column in periodically posted to the Total Goods on Approval Account.
If the goods are retained by the customer, entries are made in columns 9 to 12. The individual amounts are then posted to the debit of customer’s accounts in the Sales Ledger and their total is credited to Sales Account in the General Ledger. Further the customer’s accounts in the Goods on Approval Ledger are credited with the individual amounts of goods sold and periodically, the total of the amount is posted to the debit of Goods on Approval Total Account.
The value of goods sent out but not sold or returned till the close of the year is extended to column 13. The total of this column, afterwards, will show the value of goods with customers at the sale price.
The balance amount is calculated as follows:
Balance Value of Goods Sent on Sale or Return Less Value of Goods Returned Less Value of Goods Approved.
Information relating to goods delivered and goods returned is kept on Memorandum basis.
However, information relating to goods approved and balance is duly accounted for by passing journal entries relating to sales and Inventories on approval basis.
The amount, after eliminating the element of profit, is included in the Trading Account representing the value of Inventories with customers at cost price. Like an ordinary closing Inventories, such goods are considered as Inventories lying with customers on behalf of seller and are valued at cost or net realisable value whichever is less.
2.2.3 WHEN THE BUSINESS SENDS GOODS NUMEROUSLY ON SALE OR RETURN
When transactions are numerous, a business maintains the following books: (a) Sale or Return Day Book; and (b) Sale or Return Ledger. ‘Ledger’ contains the accounts of the customers and the ‘Sale or Return’ Total account. ‘Day Book’ is the primary book which records all transactions, and from there these are entered in the ‘Sale or Return’ Total account. It is important to remember that both are Memorandum Books, i.e.,these records are not a part of regular books of accounts.
Following procedure is adopted for recording transactions under this method:
When goods are sent to the customers on a sale or return basis, they are first recorded in the Sale or Return day Book. Thereafter, in the Sale or Return Ledger, all the customers are individually debited and the Sale or Return Account is credited with the periodical total of the Sale or Return Day Book.
When the goods are returned by the customers within the specified time, they are recorded initially in the Sale or Return Day Book. Thereafter, in the Sale or Return Ledger, the Sale or Return Account is debited with the periodical total of the Sale or Return Day Book and the individual customers are credited. The above mentioned records are all memorandum and hence cannot find a place in the regular books.
When the business receives information about the acceptance of the goods or no intimation is received within the specified time, they are recognised as sales and are recorded in the Sales Day Book. Periodically, the total of the Sales Day Book is credited to Sales Account and debited to the Individual Customers Account. To cancel the earlier entries, individual customers are credited and the Sale or Return Account is debited.
The entries for the approved goods are shown below:
At the year end, in the Sale or return Ledger, the sum of the debit balances of the Individual Customers’Account must be equal to the credit balance of the Sale or return Account. It represents Inventories with customers waiting for approval at invoice price. To adjust the cost of such goods with customers in the Final Accounts, the following entry is passed:
In short, under this method, entries are passed in the regular books of account only at the time of sale or a year end, if inventory is still lying with customers (pending approval).