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hink of a new company that makes and records credit sales of $500K in the first quarter (January-March), giving the customer the right to return the product within one year. Further assume no sales were returned by March 31. At the end of the quarter, all credit sales ($500K) are included in the quarterly income statement. Because there are still some sales that are well within the return period, the company has to make an estimate for sales returns, debiting Sales Returns and crediting the Allowance for Sales Returns. Assume that was $50K. The first quarter income would have net sales of $450K ($500K - 50K). Then , subsequently, when a customer brings back the item and, assume, gets a cash refund for $2K, we would debit the Allowance and credit Cash for $2K each. Notice, these are changes only to balance sheet accounts because we already recorded the estimated returns at the end of the first quarter. This is identical to the situation for bad debts where we record the bad debt expense by estimating uncollectibles in the same period as the sales, and then reduce the two balance sheet accounts (AR and Allowance) when we finally deem the account uncollectible and write it off.

That's the way it works: Increase the Allowance in the same period as you estimate returns, thereby reducing from gross sales to net sales in the income statement. The deductions from the Allowance occurs when actual returns take place, but only balance sheet accounts are affected by that event.