In accounting, gross refers to amounts before deductions and net refers to gross amounts minus deductions. In the context of gross and net receipts, the deductions are for sales discounts, returns and allowances. Company management may use the gross receipts to assess the effectiveness of its sales and marketing strategy, while using the net receipts to analyze whether and why deductions from gross receipts are different from historical norms. People often use the terms receipts, sales and revenues interchangeably.
The Internal Revenue Service defines gross receipts as the total amounts a company receives from all sources during its annual accounting period, without subtracting any costs or expenses. The accounting entries are to debit (increase) cash and credit (increase) sales for cash transactions, and debit (increase) accounts receivable and credit sales for credit transactions. The IRS recommends business owners ensure that sales records match the actual cash and credit receipts at the end of the day. Cash registers, software spreadsheet applications and proper invoicing systems are some of the ways to maintain complete records.
The deductions from gross receipts include returns, allowances and sales discounts. Customers often return damaged, defective or otherwise unusable products. Sometimes a customer gets to keep a defective product in return for an allowance or reduction in the selling price. The accounting entries are to debit (increase) sales returns and allowances and credit (decrease) cash or accounts receivable. Companies may track the returns and allowances amounts separately.
Some companies offer cash discounts to customers for settling their invoices early. The accounting entry is to debit (increase) sales discounts by the amount of the discount. Sales returns and allowances and sales discounts are contra revenue accounts because they reduce the gross sales amounts.
Net receipts are equal to gross receipts minus returns, allowances and discounts. The income statement shows the net receipts or net sales amount as a separate line item. For example, if a company has $1 million in gross sales and $100,000 in total sales returns, allowances and discounts, the net sales are $1 million minus $100,000, or $900,000.
Tax Tips: Gross Profits
The IRS recommends small businesses figure the gross profit by first calculating net receipts by deducting the returns and allowances from the gross receipts. The gross profit for a merchandise business is equal to the net receipts minus the cost of goods sold. Service businesses that do not manufacture or resell products may figure the gross profits directly from the net receipts.