Net Sales - Online Tutor, Practice Problems & Exam Prep

Understanding revenue involves recognizing how sales discounts, returns, and allowances can decrease it. A sales discount, such as 2/10, n/30, incentivizes early payment, while sales returns occur when customers return goods, impacting accounts receivable. Sales allowances adjust the price without returning products. The net sales formula calculates net revenue by subtracting discounts and returns from gross sales. This process is crucial for accurate financial reporting and maintaining the accounting equation, ensuring that assets, liabilities, and equity remain balanced.

Net Sales:Sales Discounts (Gross Method)

Alright, so now let's dive a little more into revenue and see what kind of things could decrease our revenue. Alright? Let's start with the first one here, a sales discount. Okay, so there's a special system we use to denote discounts, and I want to be real quick about these discounts. This is a special kind of discount. This isn't a discount where you walk into Walmart, and they say hey 50% off this - this isn't that type of discount. This is a discount for when you extend credit to a customer. So let's say you allow the customer 30 days to pay, but they pay you sooner. Okay? They're paying you quicker. Well, that's when they get this discount. Okay? So this is a discount for quick payment. Okay? And we're going to see the same thing on the purchase side, but now let's see how this deals with on the sales side. Okay? So, on the sales side, in all situations, we're going to deal with this notation, okay? We're going to see something like this where it says 2/10 net 30, which reads as 2% 10 days net 30, okay? This is like special notation they use to be extra confusing, but you just want to know what each of these numbers mean. Okay, so we've got this 2 in the 2/10 net 30. The 2 is the percentage amount of the discount, okay? So remember, we're giving the customer a discount for paying us quickly, okay? So if they pay us quick enough, they can take 2% off of the price and pay us a little less, okay? So that's the benefit to the customer for paying us quicker. Okay, so this 10, well, that's the amount of time we're giving them to get the discount, okay? So that's a number of days. So this basically says that if they pay us in the next 10 days, they can take a 2% discount off of the payment. Cool? And then the n, well that just stands for net. There's nothing really about that. It basically just tells us that the net 30, this 30, so well let me pull it from the other one over here the 30, that's the total days that you're allowed to pay, okay? And if you take till the 30th day, let's say you're paying on the 30th day, well, you don't get the 2% discount, right? Even if you're paying on the 11th day, on the 12th day, you're not going to get the 2% discount; that last number is not going to make a big difference in our calculations, okay? The numbers you really want to focus on are the 2, which is the percentage discount, and the 10, okay? So those numbers could change, right? We could see like 1/10 net 30 or 3/15 net 45, right? All these numbers can change but the meaning of the numbers stays the same. The first one is the percentage discount, then the days to receive the discount, and then finally the total days allowed. Alright? So let's go ahead and do this first example and let's go ahead and see this in action. Okay? ABC company sold 100 units of product X for $2,000 on January 10th. ABC offered terms of 3/10 net 45. Okay? So that's the important thing right there, that's our sales discount. ABC company received payment on January 19th, record the sale and receipt of cash in ABC company's books. Alright. So there's going to be 2 entries here. There's going to be the first entry when we make the sale and then a second entry when we receive the payment. Okay, so the first thing we want to consider is whether or not they're going to get the discount. Okay, so we have the sale was on January 14th, and the receipt of payment was on the 19th. So January 14th, we had the 15th, 16th, 17th, 18th, 19th. They paid you 5 days later, so this is perfectly fine, right? They made it under the 10-day threshold; they do get the discount, okay? So one more thing here, when we discuss sales discounts there are 2 methods to consider them. We can have the gross method or the net method, alright? Generally, pretty much every teacher in every textbook for the first accounting class is only going to focus on the gross method, okay? So you're pretty much likely only need to know the gross method. I'm also going to do the net method in a separate video, that way just in case your teacher you know is super vigilant and wants you to learn it, you'll have access to that as well. Okay? So let's start here with the gross method and let's do the first entry. Okay? So the sales entry is very simple. We're just going to make the entry on the sales day and when we say gross, that means the full amount. Okay? The gross amount is the full amount and it says that we sold 100 units for $2,000, right? And we haven't received any money yet, right? We gave them credit to pay us over the next 45 days. So our entry is going to be - we're going to debit accounts receivable, right? I'm going to put AR for accounts receivable and we're going to debit that $2,000 because we're owed $2,000. So now we have this asset for $2,000 we're debiting right there, and we're going to credit our revenue, right? We earned the revenue, we sold the product to the customer, so we earned our revenue at this point and we earned $2,000 in revenue. Okay? So now we're going to receive the money a few days later but remember when we receive the money we're not going to receive the full $2,000, right? They've earned the discount; they're allowed to take 3% off the price. So let's see how much we're actually going to get, right? If $2,000 was the total amount, the discount was 3%. $2,000 times 0.03 is $60 is the amount of the discount. Okay. So we're not going to receive $2,000 we're going to receive $2,000 minus $60. So $2,000 minus 60, the cash is going to be $1,940. Okay? So since they're paying us so soon, they don't have to pay us the full $2,000. They can get away with paying us $1,940. So the receipt, yes, we're going to receive cash, right? And this cash is $1,940, that's the amount of cash that we receive from the customer. So we're going to credit our revenue. So remember when we talked about contra accounts, a contra account to the revenue. So remember when we talked about contra accounts, they have an opposite balance, right? So a revenue account has a credit balance. So a contra revenue account, an account that decreases our revenue is going to have a debit balance. Okay, so we're going to have this account and we're going to call it sales discounts. Okay? And that's where the $60 is going to go, right? Because we were supposed to get $2,000, we only get $1,940 so this $60 we want to keep track of how many sales discounts we're giving to our customers, so we put them all into this account. It helps us manage how much were the sales discounts instead of just directly debiting revenue, right? If we were to just debit revenue $60, we wouldn't have as much information. Here, we're keeping all the discounts separate in this other account sales discounts. So we have our debit to cash for $1,940, our debit to sales discounts, which is right that's decreasing our revenue from the $2,000 we earned above, it's decreasing it now to a net of the $1,940 that we received. So the last thing is the credit part of this transaction. And the credit part well, we were originally owed this much money, right? We had an accounts receivable for $2,000 but we're not owed that money anymore, right? The customer made good on their payment and they paid us already. So we're going to get rid of the accounts receivable with a credit. A credit of $2,000 is going to get rid of that accounts receivable and how was it paid off? Well, we got $1,940 in cash and the rest was a sales discount. Cool? So that's what the entries look like from the gross method. Let's pause here and do the net method. Remember, not everybody's going to need to know the net method, so just double-check with your syllabus or with your teacher and see if you're going to need to focus on the net method as well. Alright, let's do that now.

Net Sales:Sales Discounts (Net Method)

Alright. So the difference with the net method is that we're going to assume that the customer is going to pay us quickly to get the discount. Okay? So this is the assumption that they're definitely going to take the discount, and then when we receive the cash, we'll adjust for that. Did we actually get the discount? Did they, or excuse me, did the customer actually take the discount or not? Okay. So when we do the sales entry, when we take our revenue in the first place, right? The problem told us we sold 100 units for $2,000. Well, we're not going to take revenue for $2,000 right away. We're going to net it to the amount of the sales discount. So we're going to do an accounts receivable because we're owed money and we are going to credit revenue just like before. Okay? So our entry is going to look very similar except instead of taking the full $2,000, we're going to take the net amount, we're going to do the cash amount, this $1,940 here, right? So what we're assuming is that the customer is going to get this 3% discount and if we do the 2,000 times 3% like we did before, we see that the discount would be $60 here. So instead of receiving $2,000, we're expecting to receive $1,940. Okay? So that's the amount we're going to put in our revenue entry. So we're going to say we're expecting to receive $1,940 in accounts receivable and we've earned revenue of $1,940. Okay? So now we have an account receivable notice at the discounted price. So now when the time comes to receive the money, this is when we would see a difference, okay? In this case, well they did take the discount, so we're fine. All we need to do is we're going to say since they paid us on time, right? They paid us within the 10 day window that they had to receive the discount, well we're going to debit our cash, they're going to pay us $1,940 in this case, right? Because that's the amount of cash we received and we're going to credit our AR for $1,940. Notice how easy the net method is when everything works out, right? If we're expecting the customer to take the discount and the customer does take the discount, well then there we go, we're set. We already have all the entries and we're pretty easy, pretty easy to do it. We just have to first calculate the net amount of revenue we would get when they take the discount. Okay? So the big trick there is to just figure out how much discount is and find the net amount of revenue. Alright, in the next example when we do the net method, we'll see a different situation where the discount is not taken, alright? So let's check out that example too.

Net Sales:Sales Discount Forfeited (Gross Method)

Alright, so let's try this example. It's pretty much the same as the example above, except I changed the payment date where we receive the money from the customer. Let's check it out. ABC Company sold 100 units of product x for $2,000 on January 14th. ABC offered terms of 3.10 net 45, right? What does that mean? That means a 3% discount if they pay us within 10 days and otherwise, they have 45 days to pay us. ABC Company received payment on February 1st, record the sale and receipt of cash in ABC Company's Books.

Alright, so let's do the gross method first. Remember I said most books and most teachers are going to focus on the gross method and just double-check if you need the net method. Most of you will not even need the net method. Alright? So from the gross method, we are going to take the gross amount of revenue on the sale date. So they didn't pay us in cash, right? They're going to pay us later so we're going to take an account receivable, right? We're going to debit account receivable for $2,000 and we're going to credit revenue for $2,000. Okay, so pretty straightforward there and then we have to see if they're going to earn the discount, right? It's January 14th, well they have 10 days to pay to earn the discount that would give them up to the 24th, right? And they didn't pay till February 1st, so they don't earn the discount, right? They didn't get the discount, they paid us the full $2,000 because they took longer than 10 days. So, we're just going to receive cash of $2,000; we debit cash $2,000 and we credit our accounts receivable for $2,000 because we're no longer owed that money.

So notice how simple it is when they don't take the discount, right? It's just, we make our accounts receivable entry and then we receive cash. So let's see the same thing from the net method, alright? Let's pause here.

Net Sales:Sales Discount Forfeited (Net Method)

Alright, let's try the same thing from the net method. So we've got this company that sold 2,000 units and we've got a 3% discount. Right? We've got a 3% discount and just like we calculated above, well, we have the 2,000 times the 3%. Right? That's the amount of the discount. That would give us a $60 discount. Right? So that means that instead of paying 2,000, they're going to pay 60 less. So instead of 2,000, they would actually pay 1,940 if they took the discount, right? When we do the net method, we assume that the customer is going to take the discount. So when we make our sales entry, we make it with the discount included. So we're going to debit our accounts receivable because we're owed money and we're going to credit revenue just like we did in the other entry, but in this case, we're going to do the net amount with the discount. So we're going to debit 1,940 to AR and 1,940 credited to revenue, right? So we've taken the net amount instead of the full 2,000. This is us assuming that the customer is going to take the discount. Well, in this case, the 10-day window passed, right? We sold it on January 14th, but they didn't pay us until February 1st, almost like 17 or 18 days later, that's past our 10-day threshold. Okay? So since they paid us after the 10-day threshold, they have to pay us $2,000 instead of $1,940, right? So the cash we're going to receive in this case is $2,000. It's not $1,940, right? We're going to receive $2,000, and we have to get rid of that account receivable. So we're going to credit accounts receivable for 1,940, right? And it has to be 1,940 not 2,000 because when we did the accounts receivable up here, it was for 1,940, so we have to get rid of it at 1,940, right? That gets it off our books, but this equation isn't balanced yet, right? So the idea is that we assumed that they were going to take the discount, but they didn't, right? They didn't end up taking the discount, so our dollars are not 1,940, so what we do to keep track of the revenue we get from the sales discounts that are forfeited, what we're going to credit another revenue account called sales discounts forfeited. Okay? This is an account right here. This is another revenue account. We're gonna have our account for our main revenue where we have the 1,940 and then we're going to have another one with the sales discounts forfeited where we're going to accumulate revenues there from people who didn't pay us quickly, okay? And that would be the $60 that they forfeited. Okay, so we received $2,000 in cash and in essence we've got 2,000 in revenue at this point. $1,940 in the revenue account and the sales discounts forfeited is going to increase our revenue, that's another revenue account there. Okay, so you can see that this is pretty straightforward when you do the gross method or the net method, right? That's about it here, so let's go ahead and pause and move on to the next video.

Net Sales:Sales Returns

Alright, so let's discuss revenue in a little more detail, and let's see how sales returns when the customer returns a good, or sales allowances can decrease our revenue. Let's check these out. So when the company sells goods, we're going to credit the revenue account, right? Pretty straightforward; we credit our revenue account whenever we sell something. So Things On Shelves (TOS) Company sold 500 units of things on account at a price of $12 per thing. Okay, so how much revenue did we earn? We sold 500 things, 500 times $12 is going to give us $6,000, right? That's what we earned, but we haven't been paid that amount, right? It says on account. So we're going to have an accounts receivable (AR) for $6,000, and we're debiting that, right? To increase our accounts receivable, and we're going to credit our revenue for $6,000 because that's how much we earned here, and how would this affect our assets? Our assets would go up by $6,000, right? And our revenue would increase our equity also by $6,000. Okay? Remember that all revenues and expenses, they flow through the income statement and they're all part of equity, okay? Revenues and expenses, they're all going to be part of equity. So there we go, we've got a pretty straightforward entry right there. Accounts receivable and revenue.

Let's do our first thing that could decrease our revenue, and this is a sales return. So if the customer returns the goods to the company, well, this is a sales return, right? They're not happy with the good and they get a refund. So the customer returned 100 units of things to TOS using the money-back guarantee policy. Well, these 100 units, right, we said that the 100 units, and we had a sales price, it was $12. Yep, up above, we had a sales price of $12. So this is the amount of money we would have had to return to the customer, right? $1,200 worth of goods. Now, let's assume that this 100 that the customer returns, they were part of this on account, right? This is the customer risk, let's say this was all one order where one customer ordered 500 things. Those things arrived at their warehouse, they inspected them and they said hey, this batch, this box of 100 things they don't meet our standards, so take them back, okay? So remember they haven't paid us yet, right? This was on account, so we have to decrease that account receivable. But the main thing I want you to see here is that we're going to be debiting an account called sales returns instead of decreasing our revenue directly. We're going to debit an account called sales returns. Okay? And this is a contra account to revenue, so when revenues go up with a credit, these sales returns go up with a debit to decrease revenue up top with that $6,000. We're going to have our gross revenue up top with that $6,000, and then we're going to be decreasing it for these types of things like a sales return. Okay? So this sales return was for $1,200, right? So when we think about our net revenue at this point, the net amount, we would have the $6,000 - the $1,200, right? We have a credit for $6,000 in the revenue account and a debit for $1,200 in the sales returns account. Okay? And we're going to credit here accounts receivable, right? Because we're no longer expecting that customer to pay us the $1,200 because they returned the goods, right? So they no longer owe us the money, we got the goods back, they owe us $1,200 less, okay? So they're still going to owe us, right? Because the AR from the previous entry, they were going to owe us $6,000, but now they returned some of it, so they're going to owe us a little less, based on that credit. Okay. So if we saw in the previous entry that our AR had gone up by $6,000, and our revenue up by $6,000. Well, now we made an entry to decrease our AR by $1,200, and we're going to decrease our equity with this sales return by $1,200. Okay? So noticed that we stay balanced here as well. Cool? Alright. So let's pause real quick and in the next video, we'll talk about the sales allowance. Alright, let's do that now.

Net Sales:Sales Allowances

Alright, so now let's discuss the sales allowance. I want to distinguish a sales allowance first from a sales return and as well from a sales discount, okay? All of these things are things that lower our revenue. So the sales return, this is where the customer was unsatisfied and they return the product, right? So we actually got the product back into our inventory. With a sales allowance, we're still dealing with an unsatisfied customer but they're going to keep the product, they just want a lower price. So instead of paying the full price, they want a discount maybe because the quality wasn't so good or whatever, they want some lower price. Okay? That's the sales allowance. Lastly, we have those sales discounts and this is where we offer the customer a discount for paying us quickly. Okay? So that's the difference. This customer is not unhappy with a sales discount. They're just paying us quicker, so they pay a little less. Okay. So let's dive into the sales allowance. So remember here, this is where the customer is going to keep the goods, but the company lowers the price. So things on shelves sold 500 things on account at $12 per thing. When low quality things arrived, the customer agreed to keep each thing at a price of $9 for this order. So notice they were unsatisfied, but they're going to keep them at a lower price. Okay? So originally, when we first sold the things, we were going to make an entry like this, right? We have our accounts receivable; we were expecting to be owed $6,000. So we're going to debit accounts receivable, right, to create the asset, and then we're going to credit our revenue for 6,000. Right? We sold these things. We thought we were going to get 6,000 and that's 6,000. Sorry, it's the same as above when we were doing the other. It was 500 things times the $12 per thing gives us 6,000. Okay? But after it got to the warehouse, the warehouse manager there inspected everything and said, you know what? We don't like the quality here, we need a lower price. Okay? So what is the amount of the lower price? $9. So what I want to think about is the amount of the discount. It went from $12 to $9, so there was a $3 discount that they got, right? So for 500 units, they got a $3 discount. Right? And this is the discount amount, and it's going to be 500 times 3 is 1,500. But remember, this isn't like a sales discount for quick payment; this is a sales allowance for selling something of low quality or something like that. So this is the amount of the allowance right here is the amount that they're paying less. Okay? So they're paying us $1,500 less, that's the allowance. So how much cash are we going to receive? So instead of paying us 6,000, they're paying us 1,500 less, so that comes out to 4,500. Right? That's the cash that we're actually going to receive from the customer. Okay? So let's go ahead and make our journal entry. First, we're going to have cash. Right? We're going to debit cash. I'm going to do it over here. Debit cash 4,500. Right? Because that's the amount of cash the customer is going to pay us at that $9 price. Then the 1,500 allowance. This is going to be a debit as well. Sales allowance is going to be a debit because it's a contra revenue account. It's a revenue account that decreases revenue, right? The idea here, our revenue we thought we were going to get $6,000, right? But we ended up only getting 4,500 in cash. So to account for that less revenue that we really got, we didn't really earn 6,000 in revenue. We do this debit account for this 1,500 where we're going to keep all our sales allowances. This makes it easier at the end of the period to say, hey, look at all these sales allowances; clearly, there's some sort of quality issue with our product, right? Something like that. We're going to debit cash, debit sales allowance, and then we're going to credit accounts receivable, right? Because we were owed this 6,000 originally, and now we're not owed 6,000 anymore, right? They paid off that obligation with the 4,500 and struck a deal to pay us less money. So we're going to get rid of that $6,000 receivable, and you can see that our entry is balanced there. Right? Our debits equal our credits, and this was our original entry over here. Cool. So we've got 2 entries there, that is the sales allowance entry on the right. So what ended up happening, we had our AR, there's going to be quite a bit in here, but let's put it all in. AR went up by 6,000, and then our cash went up by 4,500, but then our AR also went down by 6,000 in the next entry, right? We had our cash going up by 4,500 but our AR down by 6,000, so those wash out, we're left with that cash going up 4,500. Nothing with liabilities here, but on the equity side, we had revenue with revenue of 6,000, right? 6,000, and then our sales allowance is decreasing our revenue by 1,500, and that gets us to that net 4,500. So you can see that the assets went up by 4,500, equity went up by 4,500, it is balanced. So the last thing in this video is this net sales formula, okay? So our net sales is where we take our sales revenue, that's the gross amount of sales like this $6,000 that we are talking about above, and then we're going to decrease it by all of these things that might decrease it, right? The sales discounts that we saw, that's going to decrease sales revenue, as well as the sales returns and allowances are also going to decrease our revenue, our net revenue. Right? So if we take our gross amount, this is our gross amount of revenue, we subtract out some things like the discounts and the returns, we get to a net amount of revenue. Cool? Alright. So that's about it here. Let's go on to the next video.

Here’s what students ask on this topic:

What is the difference between gross sales and net sales?

Gross sales represent the total revenue generated from sales before any deductions. Net sales, on the other hand, are calculated by subtracting sales discounts, returns, and allowances from gross sales. The formula for net sales is:

$\mathrm{Net} \mathrm{Sales}=\mathrm{Gross} \mathrm{Sales}-\mathrm{Sales} \mathrm{Discounts}-\mathrm{Sales} \mathrm{Returns}-\mathrm{Sales} \mathrm{Allowances}$

This distinction is crucial for accurate financial reporting and understanding the true revenue of a business.

How do sales discounts affect net sales?

Sales discounts are reductions in the selling price offered to customers as an incentive for early payment. These discounts decrease the gross sales amount, thereby reducing net sales. For example, if a company offers terms of 2/10, n/30, it means a 2% discount is available if payment is made within 10 days. The formula to calculate the impact on net sales is:

$\mathrm{Net} \mathrm{Sales}=\mathrm{Gross} \mathrm{Sales}-\mathrm{Sales} \mathrm{Discounts}$

Understanding this helps in managing cash flow and customer relationships effectively.

What are sales returns and how do they impact net sales?

Sales returns occur when customers return previously purchased goods, often due to defects or dissatisfaction. These returns reduce the accounts receivable and the gross sales amount, thereby decreasing net sales. The formula to account for sales returns in net sales is:

$\mathrm{Net} \mathrm{Sales}=\mathrm{Gross} \mathrm{Sales}-\mathrm{Sales} \mathrm{Returns}$

This adjustment is essential for accurate financial reporting and inventory management.

What is a sales allowance and how does it affect net sales?

A sales allowance is a reduction in the selling price granted to customers who keep defective or unsatisfactory goods. Unlike sales returns, the customer retains the product but pays a lower price. This reduction decreases the gross sales amount, thereby impacting net sales. The formula to account for sales allowances in net sales is:

$\mathrm{Net} \mathrm{Sales}=\mathrm{Gross} \mathrm{Sales}-\mathrm{Sales} \mathrm{Allowances}$

Understanding sales allowances helps in assessing product quality and customer satisfaction.

How do you calculate net sales?

Net sales are calculated by subtracting sales discounts, returns, and allowances from gross sales. The formula is:

$\mathrm{Net} \mathrm{Sales}=\mathrm{Gross} \mathrm{Sales}-\mathrm{Sales} \mathrm{Discounts}-\mathrm{Sales} \mathrm{Returns}-\mathrm{Sales} \mathrm{Allowances}$

This calculation is crucial for accurate financial reporting, as it reflects the true revenue after accounting for all deductions. It helps businesses understand their actual earnings and make informed financial decisions.