Under ASC 606, journal entries for the allowance for sales returns and allowances have two sides that must be booked together: a revenue side that splits the sale between recognized revenue and a refund liability, and an inventory side that splits cost of goods sold between what you expect to stay sold and a right-of-return asset for what you expect back. When an actual return arrives later, you clear those estimated balances rather than touching revenue or cost of sales again.
The example below runs the full cycle using one set of numbers so each entry connects to the next.
Entries at the Time of Sale
Assume a company sells $50,000 of product on credit. The cost of that inventory is $10,000, and historical experience says 6% of these sales will come back.
The receivable goes on the books at the full invoiced amount, because that is what the customer owes. Revenue, though, is only recognized for the $47,000 the company expects to keep. The other $3,000 sits as a refund liability.
- Debit Accounts Receivable: $50,000
- Credit Revenue: $47,000
- Credit Refund Liability: $3,000
The inventory side mirrors that split. Cost of goods sold is recorded only for the units the company expects to stay sold. The cost of the units it expects back is parked in a right-of-return asset, which represents the inventory it anticipates recovering. At initial measurement, that asset is the original cost of the goods expected to be returned, reduced by any expected recovery costs and any anticipated decline in value.1PwC. Revenue from Contracts with Customers – 8.2 Rights of Return
- Debit Cost of Goods Sold: $9,400
- Debit Right-of-Return Asset: $600
- Credit Inventory: $10,000
Both entries happen at the same moment the sale is recorded. Skipping the inventory side is a common error carried over from pre-ASC 606 habits, when companies often booked only a contra-revenue entry and a contra-asset allowance. The current standard requires tracking the inventory side explicitly.
Entries When a Return Actually Arrives
Say a customer later returns $2,500 of the merchandise, which carried a cost of $500. The revenue hit was already taken at the time of sale, so the return entry does not touch revenue or cost of sales. It clears the estimated balances instead.
- Debit Refund Liability: $2,500
- Credit Accounts Receivable: $2,500
The returned goods come back onto the books and clear the corresponding portion of the right-of-return asset:
- Debit Inventory: $500
- Credit Right-of-Return Asset: $500
This is the piece that trips people up. Running returns through revenue a second time double-counts the impact. The estimate at the time of sale already reduced revenue; the return entry is a settlement of that estimate, not a fresh event.
Adjusting the Estimate at Period End
Estimates miss. ASC 606 requires reassessing the refund liability and the right-of-return asset at each reporting date to reflect updated expectations.
If actual returns are running below what was estimated, reduce the refund liability and recognize additional revenue (with a parallel adjustment on the inventory side). If returns are running higher than estimated, increase the refund liability and reduce revenue. These true-ups flow through the current period’s income statement; prior periods are not restated for a routine change in estimate.
Auditors look closely at this account because low-balling the estimate is one of the easier ways to quietly inflate reported revenue. A disciplined estimation process produces small quarterly adjustments; a weak one produces material swings.
Sizing the Estimate Behind the Entries
The numbers you plug into the entries above come from an estimate of expected returns, and ASC 606 sanctions two approaches. The expected value method uses a probability-weighted average across possible outcomes and fits a company with a large volume of similar transactions. The most likely amount method picks the single most probable outcome and fits a contract that essentially has two possible results.2PwC. Revenue from Contracts with Customers – 4.3 Variable Consideration
The common working method is a historical percentage of sales. If last year’s gross sales were $1,000,000 and actual returns totaled $40,000, the historical return rate is 4%, and that rate gets applied to current credit sales. Adjust the baseline for anything that would push the real rate off historical: a new product launch, a changed return policy, seasonal patterns, a recall. Winter apparel sold in November, for instance, should expect a January return spike that a rolling twelve-month average can understate.
ASC 606 also constrains how aggressive the estimate can be. Expected returns are variable consideration, and revenue is recognized only to the extent a significant reversal in cumulative revenue is probable not to occur.2PwC. Revenue from Contracts with Customers – 4.3 Variable Consideration If you are not reasonably confident a sale will stick, you cannot book it as revenue yet.
Sales Returns Versus Sales Allowances
The account name covers two situations, and both run through the same entries. A sales return is a customer shipping merchandise back for a full or partial refund. A sales allowance is a price reduction offered to a customer who agrees to keep damaged or defective goods instead of returning them.
The entries differ in only one respect: a pure price concession has no inventory coming back, so the inventory-side entry is not needed. The revenue-side mechanics are the same. Debit the refund liability, credit accounts receivable (or cash if a refund is issued), for the amount of the concession.
What These Entries Do Not Get You at Tax Time
The journal entries above produce GAAP financial statements. They do not produce a tax deduction for the estimated portion. Under the Internal Revenue Code’s all-events test, a deduction requires economic performance, and the event giving rise to the liability must actually have occurred.3Office of the Law Revision Counsel. 26 US Code 461 – General Rule for Taxable Year of Deduction
An estimated future return has not happened. The customer still has the goods. No deduction exists until the merchandise physically comes back and the refund is issued. The result is a temporary book-tax difference: lower revenue on the GAAP statements because estimated returns were already subtracted, higher taxable income on the return because the IRS does not accept the estimate.3Office of the Law Revision Counsel. 26 US Code 461 – General Rule for Taxable Year of Deduction Accrual-basis companies typically track that gap through a deferred tax asset that reverses as actual returns occur.