Introduction, Meaning Sale of Goods for Approval or Returned

Sale of goods on approval or return is a conditional sale where the buyer has the option to either accept or return the goods after a certain period of time. If the buyer approves the goods, the sale is finalized, and ownership is transferred. If the buyer returns the goods, no sale is recognized, and the goods remain the property of the seller.

Transaction type:

1. No immediate sale: The goods are delivered to the buyer, but no sale is recognized at this point.
2. Ownership retention: The seller retains ownership of the goods until the buyer approves them.
3. Return option: The buyer can return the goods within the stipulated approval period without obligation.
4. Sales recognition: The sale is recorded only when the buyer signals approval or the approval period expires without a return.

This type of sale is typically formalized in contracts, stipulating the approval period, the return process, and conditions under which the transaction becomes final.

Accounting for Sale of Goods on Approval or Return Basis

When it comes to accounting for sales on approval or return, proper treatment ensures that financial statements reflect an accurate picture of the company’s sales and inventory position. Below are the key steps in the accounting process for such transactions.

1. When Goods are Sent on Approval

At the time of sending the goods to the buyer, ownership is not transferred, so it is not treated as a sale in the seller’s books. The goods are still considered part of the seller’s inventory. A memo entry or special record is maintained to track the goods sent.

• No journal entry for sales at this point since ownership has not been transferred.

2. When the Buyer Approves the Goods (Sale Confirmed)

If the buyer approves the goods or does not return them within the specified period, the sale is recognized. The sale and the cost of goods sold (COGS) are recorded at this point.

• Journal Entry for Recording the Sale:
  • Debit: Accounts Receivable / Cash (for the sale amount)
  • Credit: Sales Revenue (for the sale amount)
• Journal Entry for Recording the Cost of Goods Sold:
  • Debit: Cost of Goods Sold (COGS)
  • Credit: Inventory (for the cost price of goods)

3. When the Goods are Returned by the Buyer

If the buyer decides to return the goods within the approval period, no sale is recorded. The goods are simply returned to inventory, and the memo or special record is updated to reflect the return.

• No journal entry for sales cancellation since the sale was never recognized. The inventory is restored, and no financial impact occurs other than updating the stock records.

4. When the Buyer Partially Approves the Goods

In cases where the buyer approves some goods and returns others, a partial sale is recorded for the approved goods, and the rest are returned to inventory.

Journal Entry for Partial Sale:

• • Debit: Accounts Receivable / Cash (for the approved portion)
  • Credit: Sales Revenue (for the approved portion)

Journal Entry for Recording Partial COGS:

• • Debit: Cost of Goods Sold (for the cost of approved goods)
  • Credit: Inventory (for the cost of approved goods)

5. When the Approval Period Expires without Buyer’s Response

If the buyer does not communicate approval or return within the stipulated time frame, the goods are deemed accepted, and the sale is recorded on the expiration date.

Journal Entry for Sale:

• • Debit: Accounts Receivable / Cash
  • Credit: Sales Revenue

Journal Entry for COGS:

• • Debit: Cost of Goods Sold
  • Credit: Inventory

Example of Accounting Entries:

Let’s consider an example to illustrate the accounting entries for a sale on approval basis:

• On July 1, ABC Ltd. sends goods worth $5,000 (costing $3,000) to a customer on approval. The customer has 30 days to either approve or return the goods.
• On July 15, the customer approves the goods, and the sale is finalized.

1. When Goods are Sent on Approval (July 1):

• Memo Entry: No journal entry is passed in the books as ownership has not yet transferred. However, a note or memo entry records that goods have been sent.

2. When the Customer Approves the Goods (July 15):

Journal Entry to Record Sale:

• • Debit: Accounts Receivable $5,000
  • Credit: Sales Revenue $5,000

Journal Entry to Record COGS:

• • Debit: Cost of Goods Sold $3,000
  • Credit: Inventory $3,000

If the customer had returned the goods within the approval period, no entry would have been required, and the goods would simply be returned to inventory.

Importance of Proper Accounting for Sale of Goods on Approval:

Proper accounting treatment of sales on approval or return basis is important for several reasons:

• Accurate Financial Reporting:

Revenue is only recognized when it is earned, ensuring that the company’s income statement reflects true sales figures.

• Inventory Management:

Goods sent on approval remain part of the company’s inventory until the sale is finalized, helping in accurate stock valuation.

• Compliance with Accounting Standards:

Adhering to the matching principle and revenue recognition criteria is essential for compliance with accounting standards, such as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS).

• Risk Management:

Since ownership remains with the seller until approval, it reduces the seller’s risk of revenue overstatement or misrepresentation of financial performance.