How should customer returns be handled with respect to accounting?

[KJ23]

I'm in the process of writing an ERP for a small online retail business and I am a little confused on how to handle customer returns/cancelled orders.

When a customer places and order, the following occurs:

- Merchandise Sales revenue account balance increases
- COGS expense account balance increases
- PayPal bank account balance increases (all sales go through PayPal)
- Decrease inventory for items in the order (which in turn causes the Inventory Asset account to decrease)

What I'm wondering is how to handle customer returns. I could just simply "ignore" all of the financial information from the returned/cancelled order (i.e. either delete it from the database, or not include it when calculating the account balances), but this doesn't seem like the right approach because it could cause reports to be inconsistent (for instance, if I run a report before and after an order is cancelled, with this approach the report for after the order was cancelled wouldn't show the cancelled order anywhere and so the numbers would not match up with the report generated before the order was cancelled. Instead, I'm leaning towards adjusting all of the accounts, essentially doing all of the above steps in reverse:

- Add an adjustment to the Merchandise Sales revenue account balance to decrease it
- Add an adjustment to the COGS expense account balance to decrease it
- Pay the order amount as an expense into a "refunds" expense account from the PayPal bank account
- Increase inventory for the items in the order (which in turn causes the Inventory Asset account to increase)

Is that the right approach?

 

[kirby]

Yes, except create 4 new specific accounts for the returns. For example instead of a decrease to the Merchandise Sales revenue account, post it to a new account that comes after the Merchandise Sales revenue account in your chart of accounts and call it "Merchandise Sales Returns" and holds the debits from the returns. So your net sales is the sum of the two accounts. By using a separate returns account the accounting folks can, at a glance, see the % of returns versus having to do a query to get this info.