Globally, it’s estimated that retailers lose more than $761 billion worth of merchandise each year because of returns. This number—while already large!—continues to increase. In 2021, retail purchase returns jumped to an average of 16.6%, a significant increase compared to an average of 10.6% reported the year before.
The return of goods can be costly to small businesses. But if you have an understanding of how purchase returns work and implement a strong return policy, it could boost your company’s operations.
This article will walk you through everything you need to know about purchase returns, including the following topics:
Purchase return definition
A purchase return is when a buyer (either a business or an individual) returns goods that they bought to the seller for a refund or store credit, depending on the seller’s policy.
The buyer might make these returns for various reasons, as long as they align with local laws and the seller’s return policy. Maybe they were unhappy with the product. Perhaps they mistakenly purchased incorrect items, or the seller sent them the wrong products. Or maybe they bought too much of an item and want to return a portion of their order.
To account for how time-consuming and costly processing merchandise returns can be, your business should have a purchase returns account under the periodic inventory system. This purchase returns account should have a credit balance to offset any debits made when items are returned and to properly track those losses.
In addition to the financial impact of your company’s return policy, if it’s not very shopper-centric or forgiving, it can also affect your customers’ brand loyalty. A more lenient return policy can lead to a long-term relationship with customers.
About 72% of shoppers in one survey said that if they have a positive experience making a return to a company, they’re more likely to shop with them again. Another study shows that if an online store offers free returns, customers are likely to spend up to 357% more than they did before making a return.
The 5 most common reasons customers return goods
Of course, customers return items for a number of different reasons. Whether they can make a purchase return depends, largely, on local laws and your company’s return policy. No matter the reason, a return will likely be a financial loss for your business. At the same time, a flexible return policy can help you build brand loyalty.
1. Damaged products
A customer might have a good reason for returning an item, for instance, if it’s damaged or defective in any way. When a customer purchases faulty goods, they have two options to remedy the situation: Ask the seller to replace or return the faulty goods.
In fact, many countries legally require a seller to accept the return of a defective, faulty, or broken item. As you establish a return and refund policy for your business, you should understand the laws in your U.S. state or country regarding these matters.
If the item is damaged while being shipped to the buyer by a third party, your local laws might clarify who’s responsible for damaged merchandise. In many cases, while a seller might have to handle the initial purchase return for a customer, they can file a claim against the carrier. That depends on your contracts with UPS, FedEx, and other 3PL companies.
Understanding all of these factors can help you establish a strong policy for how to handle purchase returns related to damaged products. This can ensure that the items are handled properly upon their return and that you’re keeping customers happy.
2. Wrong style, size, or color
A customer receiving the wrong item—maybe it’s the wrong style, size, or color—is another instance where they might seek a replacement or a return. If they don’t want to wait for a replacement item or your company doesn’t have the correct item in stock, they’ll likely request their money back.
Whether you process their return will likely fall on local laws regarding returns and the circumstances of the return. If a customer received an incorrect item because you mistakenly sent it, that’s a breach of contract and you’d be responsible for making that refund.
However, if the customer mistakenly purchases a blouse in the wrong size or selects the wrong shoe color when placing an order, that isn’t considered a breach of contract. This is when you’ll need to evaluate your return policy and how lenient you want it to be, as well as your relationship with your customers.
3. Wrong product
According to one survey, 23% of customers said their top reason for returning a product is because they received the wrong item.
As a seller, you’ll need to look at the reason your customer received the wrong item. Is your company at fault? In this case, in many countries and U.S. states, you’d legally be on the hook for accepting that return.
However, if the customer mistakenly ordered the incorrect item or model of a product, you likely aren’t legally required to process that return, depending on where you’re operating from. But it’s another opportunity to consider how forgiving your return policy should be as you build strong relationships with your customers.
4. Late delivery
In some cases, a delay in a shipment’s arrival can impact whether the items ordered will be useful to a customer. Maybe they needed the item for a specific event or by a certain date. If a customer receives their order after their expected delivery date, they might ask to return it for a refund.
Again, depending on your local laws, you could be required to process that refund. But it’s also another area where you can improve customer relations—not just by revamping your return policy but also by taking a look at your options for shipping.
According to one study, 69% of shoppers say they’re less likely to shop with a company again if they don’t receive a purchase within two days of the date they were promised it would arrive. Consider offering additional shipping options, and features like track shipping, so customers know where their item is every step of the way.
5. Change of mind
Sometimes, a customer will simply change their mind about a purchase and request a refund. They could have buyer’s remorse and decide that their purchase no longer suits them, or they might determine they don’t actually need it. Or who knows—their child might have even gotten their hands on an unlocked tablet and made an unwanted and unnecessary purchase!
As a business owner, this is the area where you can offer the most flexibility on returns. Customers are more likely to build long-lasting relationships with companies that make it easy for them to return items, even if the reason for the return is simply that the consumer changed their mind.
Accounting for purchase returns
When a buyer records a purchase return, one of two things can happen:
- It can be credited to your company’s inventory account—which works best with a small number of returns, or
- It can be credited to an account dedicated to purchase returns.
The latter works best if you have a high volume of business transactions (and, therefore, returns) to process. Just make sure the value of goods returned to your business is deducted from the purchases.
Journal entries for purchase returns
When creating journal entries (i.e., records of your daily business transactions) in your general ledger, keep in mind that there’s no way for your business to have a debit balance for purchase returns. When a return—also called a contra-expense account—is made, the balance of the return will either be a credit or zero. Essentially, processing a purchase return reduces your company’s purchase expenses.
You should use a double-entry system—a concept of modern bookkeeping and accounting that says every financial transaction your business completes will have equal and opposite effects on at least two of your company’s accounts. Essentially, this means your credits are offset by any debits made and should be reflected on your company’s balance sheet and other financial statements.
Learn more about the journal entries you might create for a return below.
Credit purchase return
When a buyer purchases an item using credit, it means they’ll get the goods they purchased immediately but will pay you later. In this sales transaction, you’d debit your inventory account in your books and note a credit to accounts payable.
For instance, let’s say a T-shirt printing company buys $5,000 worth of shirts in bulk from you on credit. They won’t pay for this upfront; instead, they’ll make installments.
If the customer decides to make a purchase return, though, you’ll need to debit your accounts payable and credit your purchase returns account in your journal entry.
Here’s an example of how you—the seller—might create a journal entry for this credit purchase return:
Debit: Accounts payable (decrease liability)
When creating a journal entry for a credit purchase return, the seller will debit accounts payable because accounts payable is a liability incurred when making the sale. This initial liability when the sale takes place is an obligation for your company to settle at some point. Debiting accounts payable during the return process reduces your business’s liability, meaning the debt is being paid and cash becomes an outflow.
Credit: Purchase returns (decrease expenses)
When making a credit purchase return, the seller will credit their purchase return account in the transaction’s journal entry. This will indicate that there is a decrease in the company’s expenses.
Cash purchase return
When the buyer pays for the original purchase in cash, that means you’re paid upfront and can expect the money immediately. To record this initial sales transaction in your journal, you’d debit your inventory account and mark a credit to your cash account.
If you decide to offer the customer a purchase discount for paying upfront in cash, make sure that’s noted on your income statement or journal entry somewhere.
When making a cash purchase return, though, you’ll debit your receivable account and credit purchase returns. Using the same example of a T-shirt company purchasing clothing items and then returning them, your journal entry would look like this:
Debit: Receivable (increase in assets)
If the buyer were to return their purchased goods (either a portion or all of the items bought from you), a debit to your receivable account would indicate an increase in your company’s assets.
Credit: Purchase return (decrease in expenses)
Meanwhile, when making a cash sales return, you should credit your purchase returns account. This would show a decrease in expenses for your company.
The advantages of a purchase return journal entry
There are a couple of big benefits to recording a journal entry when a purchase return is made.
It helps keep track of return transactions
Having every transaction on record helps your company keep track of returns. It ensures the customer’s return will be handled professionally and on time.
Comprehensive records are important to keep your running smoothly and staying in business, especially when you consider the fact that shoppers return anywhere from 10% to 40% of their e-commerce orders. With all your returns recorded in one place, it simplifies the auditing process, as well.
It helps reduce the balance of return transactions from the total inventory
When your company records the return of purchases, it can help reduce the balance of these return transactions from your total inventory. It creates an accurate understanding of your company’s inventory status at any given moment.
Record purchase returns the right way
Upwork’s network connects independent accounting professionals with the businesses that need their help the most. Freelance branding experts can also help your company evaluate how a robust returns policy can improve consumer brand loyalty.
If you’re a company that needs accounting help, like creating journal entries for purchase returns, Upwork can help you find the right professional for your team.
