Recording Sales of Inventory: Revenue, COGS, and Returns

Why sales of inventory require more than one entry

When a company sells inventory, two different things happen at the same time:

• Revenue side: you earn revenue (and often create a receivable if the customer will pay later).
• Cost side: you give up an asset (inventory) and recognize an expense for what that inventory cost you (COGS).

How you record the cost side depends on whether you use a perpetual or periodic system.

Perpetual system: the two-part entry at the time of sale

In a perpetual system, you update inventory and COGS continuously. Each sale normally triggers two journal entries.

Part 1: Record the sale (revenue entry)

This entry records what the customer owes (or pays) and the revenue earned.

Dr Accounts Receivable (or Cash)   XXX
    Cr Sales Revenue                   XXX

Part 2: Record the cost (COGS entry)

This entry moves the cost of the items sold out of Inventory and into expense.

Continue in our app.

You can listen to the audiobook with the screen off, receive a free certificate for this course, and also have access to 5,000 other free online courses.

Or continue reading below...

Download the app

Dr Cost of Goods Sold (COGS)       YYY
    Cr Inventory                       YYY

Key idea: Sales Revenue is recorded at the selling price; COGS is recorded at the inventory cost (based on the company’s costing method).

Periodic system: only the sales entry during the period

In a periodic system, you do not reduce Inventory or record COGS each time you sell something. During the period, you typically record only the revenue side:

Dr Accounts Receivable (or Cash)   XXX
    Cr Sales Revenue                   XXX

Later, at period-end, you compute COGS in total and update Inventory through adjusting entries. Practically, this means that during the month/quarter, the ledger does not show real-time Inventory and COGS from sales.

Sales returns and allowances: what they do to revenue

Returns and allowances reduce the amount of revenue you keep from customers. Many companies track these reductions in a separate contra-revenue account such as Sales Returns and Allowances (instead of directly debiting Sales Revenue). This makes gross sales and reductions visible.

Return/allowance entry (revenue reversal)

When you accept a return or grant an allowance and you refund cash or reduce what the customer owes:

Dr Sales Returns and Allowances    XXX
    Cr Accounts Receivable (or Cash)   XXX

Effect: Net sales decreases because contra-revenue increases.

Additional perpetual-only effect: reverse inventory and COGS for physical returns

If goods are physically returned to stock, a perpetual system also reverses the cost side. You put the item back into Inventory and reverse the portion of COGS related to the returned item(s):

Dr Inventory                       YYY
    Cr Cost of Goods Sold (COGS)       YYY

Important distinction:

• Return (goods come back): revenue is reduced; under perpetual, Inventory increases and COGS decreases.
• Allowance (customer keeps goods): revenue is reduced; there is typically no Inventory/COGS reversal because nothing is returned to stock.

Mini case: sale and partial return (entries under each system)

Scenario: A company sells 10 units on account for $50 each (total selling price $500). The inventory cost is $30 per unit (total cost $300). The customer later returns 2 units. The company issues a credit memo (reduces Accounts Receivable). Assume the returned units are in resalable condition.

Step 1: Record the original sale

Perpetual system (two-part entry)

(A) Revenue entry:

Dr Accounts Receivable             500
    Cr Sales Revenue                   500

(B) Cost entry:

Dr Cost of Goods Sold              300
    Cr Inventory                       300

Periodic system (sales entry only during the period)

Dr Accounts Receivable             500
    Cr Sales Revenue                   500

No COGS/Inventory entry is recorded at the sale date under periodic.

Step 2: Record the partial return (2 units)

The selling price being reversed is 2 × $50 = $100. The cost being reversed (if perpetual and goods are returned to stock) is 2 × $30 = $60.

Perpetual system (two effects)

(A) Reduce revenue via contra-revenue and reduce A/R:

Dr Sales Returns and Allowances    100
    Cr Accounts Receivable             100

(B) Reverse the cost and restore inventory:

Dr Inventory                        60
    Cr Cost of Goods Sold               60

Periodic system (revenue reduction only during the period)

Dr Sales Returns and Allowances    100
    Cr Accounts Receivable             100

Under periodic, there is still no immediate Inventory/COGS reversal at the return date. The return’s impact on COGS is captured indirectly when COGS is computed later for the entire period.

Quick comparison: what changes immediately?