How to account for refunds and returns on your books

How to Issue a Refund to Customers

Sometimes money needs to be returned. It's essential that bank accounts are updated and the proper Chart of Accounts items.

Sooner or later, a customer is going to request a refund. In terms of your company's books, it's crucial to not only acknowledge the money going out instead of in, but it's also vital to ensure that your returns are being tracked correctly. There are two ways to do this that will satisfy your accounting needs. Each method has its pros and cons.

Both require that the system track the value of returns; because that's something that gets reported during tax time. Both debit the value of the return to that special tracking account. 

One way is to use the built-in Credit Note functionality. The other is to create a transaction when the refund hits the reconciliation screen. 

Option 1: Refund using Credit Note functionality 

This method creates a separate credit note on the system. It has the advantage that the credit note will appear in a company's transaction history from their contact page. 

  • Locate the applicable invoice and open

  • Click on the grey "More" button at the top right.

  • Select 'Create credit note.'

  • A credit note screen will appear. It looks like the invoice screen, but at the top left the header displays "Create credit note."

  • The table at the top right of the screen includes a field that shows which invoice to this credit will be applied. In this case, it is invoice #1073 for customer Refund Me Corporation 

  • The credit note usually only needs one line. The entire amount of the goods and services included in the invoice needs to be added to your Chart of Accounts account, which tracks returns. 

  • If you have not yet done so, please create a product called Returns. The Revenue category should be your return tracking account. Note: for the default Chart of Accounts, this is '620 - Sales returns and allowance.'  If there is a tax rate the typically applies, please add that to the settings - otherwise, leave that blank.

  • Complete the Credit note form 1) The product should be your returns product. 2) Be sure that if taxes were applied on the invoice the same taxes are also applied on the credit memo. 3) If more than one tax rate was used on the invoice, create a line for each tax rate, and apply them. 4) You might also want to select a template if sending a copy to the customer. 

  • Once you’re certain the set up is correct, click the green "Approve" button at the top right.

  • Once the approval is completed, if the transaction number link in the right-hand column is clicked, the associated account updates can be viewed. 

  • In the credit note a) Sales returns and allowances debited (increased) by $500.00 b) Sales tax collected was debited (decreased) by $5.00 c) Accounts receivable was credited (decreased) by $505.00 d) notice that the Sales account was not touched; that's because the sale has already taken place, even if the product or services have not yet been delivered.

  • Compare this to the original sales invoice where a) Sales was debited (increased) by $500.00 b) Sales tax collected was debited (increased) by $5.00 c) Accounts receivable was credited (increased) by $505.00

  • When the transaction for the credit note comes in from the bank, reconcile the transaction to the Credit note. This will update the system to show that the account balance and accounts receivable have both decreased.

  • Notice how when the system displays the credit notes, they are indicated by an orange "CN" 

The credit note method is more 'technically correct' and ensures that the full picture is available when a customers’ transaction history is displayed. On the other hand, it takes a little more work and uses up one of the sequential invoice numbers. 

Now we are going to discuss the second method, which takes less effort. 

Option 2: Refund by transaction functionality  

  • Before beginning, make sure that there is an account in your chart of accounts to track returns amounts. 

  • Go to Accounting > Chart of Accounts. 

  • If you cannot locate a returns account, create one by clicking on the green "Create Account" button at the top right and selecting 'create an account' -- note: this is classified as a Revenue account even though it reduces revenue.

  • Next, locate the transaction by clicking on Bank Accounts in the left nav

  • Chose the payment account from the select menu at the top left.

  • Locate the refund transaction on the screen. 

  • If no Credit note has been created there is nothing with which to match the transaction.

  • Instead, click on the "Create another transaction" link

  • Notice that the transaction is assigned a tracking number, but it is not part of the invoice number series. 

  • Set the account to be credited to your system's returns account. Note: for the default Chart of Accounts, this is '620 - Sales returns and allowance.'  

  • If there was a tax amount applied to the original invoice, apply it here. Note: you are limited to a single tax rate. 

  • Click the green "Match" button

  • The transaction will disappear from the screen. (However, if you go back to the payment accounts home screen, the newly reconciled transaction will be displayed.)

  • If the transaction is located in the journal the following entries are displayed a) Sales returns and allowances is debited (increased) by $500.00 b) Sales tax collected is debited (decreased) by $5.00 c) the balance of the bank account is decreased by $505.00

  • If the original invoice is viewed, it now has a zero balance.

This keeps all the transaction data in one place; however, when the customer's account history is displayed it doesn't show that there was a payment involved. It was credit. 

Which one should be used? That's up to you. Which one makes more sense to you? 

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