A sales allowance is a reduction in the price charged by a seller, due to a problem with the sold product or service, such as a quality problem, a short shipment, or an incorrect price. Thus, the sales allowance is created after the initial billing to the buyer, but before the buyer pays the seller. The sales allowance is recorded as a deduction from gross sales, and so is incorporated into the net sales figure in the income statement.
For example, a company ships products that are slightly out of specification. The original billing was for $10,000, and the company convinces its customer to pay for the out-of-spec goods with a sales allowance of $1,000. The journal entry recorded by the company for the sales allowance is a debit of $1,000 to the sales allowance account and a credit to the accounts receivable account of $1,000.
The sales allowance account is a contra account, since it offsets gross sales. The result of the pairing of the gross sales and sales allowance accounts is net sales. There is normally a debit balance in the sales allowance account.
Management usually wants to record sales allowances in a separate account, so that the aggregate amount of allowances given is clearly visible. A large balance in this account is an indicator that a business has considerable problems with its products, or damage to those products while in transit.