Default in Payment and Partial Return of Goods

Default is failure to meet the legal obligations (or conditions) of a loan, for example when a home buyer fails to make a mortgage payment, or when a corporation or government fails to pay a bond which has reached maturity. A national or sovereign default is the failure or refusal of a government to repay its national debt.

Default is the failure by a debtor to make a principal or interest payment in a timely manner. The result can be the loss of collateral or even a bankruptcy filing by the debtor. This situation occurs when the cash inflows of a business are exceeded by its cash outflows, leaving no cash with which to make debt payments.

Types:

Sovereign defaults

Sovereign borrowers such as nation-states generally are not subject to bankruptcy courts in their own jurisdiction, and thus may be able to default without legal consequences. One example is Greece, which defaulted on an IMF loan in 2015. In such cases, the defaulting country and the creditor are more likely to renegotiate the interest rate, length of the loan, or the principal payments. In the 1998 Russian financial crisis, Russia defaulted on its internal debt (GKOs), but did not default on its external Eurobonds. As part of the Argentine economic crisis in 2002, Argentina defaulted on $1 billion of debt owed to the World Bank.

Orderly default

In times of acute insolvency crises, it can be advisable for regulators and lenders to preemptively engineer the methodic restructuring of a nation’s public debt also called “orderly default” or “controlled default”. Experts who favor this approach to solve a national debt crisis typically argue that a delay in organising an orderly default would wind up hurting lenders and neighboring countries even more.

Strategic default

When a debtor chooses to default on a loan, despite being able to service it (make payments), this is said to be a strategic default. This is most commonly done for nonrecourse loans, where the creditor cannot make other claims on the debtor; a common example is a situation of negative equity on a mortgage loan in common law jurisdictions such as the United States, which is in general non-recourse. In this latter case, default is colloquially called “jingle mail”—the debtor stops making payments and mails the keys to the creditor, generally a bank.

Sovereign strategic default

Sovereign borrowers such as nation-states can also choose to default on a loan, even if they are capable of making the payments. In 2008, Ecuador’s president Rafael Correa strategically defaulted on a national debt interest payment, stating that he considered the debt “immoral and illegitimate”.

Partial Return of Goods

If a customer wishes to return a defective item after they have paid for them, then generally you will need to issue a refund. According to Terms Feed, a company that prepares legal agreements for businesses, most businesses have a returns and refund policy that specifies when customers may return an item, and whether they be be compensated in cash or with store credit.

In accounting, refunds are handled through a contra-revenue account known as the sales returns and allowances account, reports Accounting Coach. When you issue a refund, you make a refund double entry, which means you must adjust two separate accounts in your records. First, record a debit to the “sales returns and allowances” account in a journal entry for the amount of the refund or allowance. A debit increases this account.

Cash and Receivables Accounts

In expense refund accounting, the second account you must adjust is either cash or accounts receivable. If the customer has already paid for the item and you refunded her cash, credit the cash account for the amount of the refund in the same journal entry. If the customer has yet to pay for the initial purchase, credit accounts receivable instead. A credit reduces these accounts, which are assets, on the balance sheet.

Reporting on the Income Statement

A business lists the “sales returns and allowances” account below gross revenue on the income statement and reports “net sales” below that. Net sales equals gross revenue minus the sales returns and allowances for the period. Alternatively, you can report net sales on the income statement and report gross revenue and sales returns and allowances in the footnotes.

Analyzing Refunds

It is important to assess refunds as a portion of gross sales each period to make sure you’re not giving back too much revenue. This portion as a percentage equals sales returns and allowances divided by gross revenue, times 100. An increasing percentage over time can alert you to potential problems with your products.

Creating a sales return and allowances journal entry

Accounting for sales returns can be tricky. But, don’t be overwhelmed by debits and credits. Once you get the hang of which accounts to increase and decrease, you can record purchase returns and allowances in your books.

Your responsibilities depend on how the original purchase was made and how you plan on reimbursing the customer.

But, regardless of how the customer paid, one thing remains the same: you need to update your Sales Returns and Allowances account. This account represents returned goods at your business.

The Sales Returns and Allowances account is a contra revenue account, meaning it opposes the revenue account from the initial purchase. You must debit the Sales Returns and Allowances account to show a decrease in revenue.

Your sales returns and allowances journal entry should look like this:

Sales returns and allowances journal entry should look like this:

When a customer returns something they paid for with credit, your Accounts Receivable account decreases. Reverse the original journal entry by crediting your Accounts Receivable account. Although you don’t lose physical cash, you lose the amount you were going to receive.

Inventory record should look something like this: