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Sale or Return Goods - IFRS 15

Richard Clarke

Sale of Goods with Right of Return under IFRS 15

Introduction to IFRS 15 Guidance on Returns

When an entity sells goods with a right of return, revenue should be recognised for only those goods expected to be kept by the customer.

The other goods are instead recorded as a refund liability.

These need a corresponding “asset” for the goods expected to be returned, measured at the carrying amount of the inventory, less any potential costs to recover the goods.

Key Steps and Concepts

  1. Identifying the Contract and Performance Obligations:
    The sale of goods and the return option are considered as a single contract. The performance obligation is the transfer of the goods to the customer, while the return option is a form of variable consideration.

  2. Variable Consideration and the Constraint:
    Estimate the amount of returns and recognise revenue only for the amount not expected to be returned.

  3. Recognition of a Refund Liability and a Return Asset:

    • Refund Liability: Represents the consideration that is expected to be returned to customers (e.g., cash refunds, store credits).
    • Return Asset: Represents the right to recover inventory expected to be returned. It is measured at the original cost of the goods, adjusted for any anticipated reduction in value.

Numeric Example

Scenario:

  • A retailer sells 1,000 units of a product at $50 each.
  • Based on historical experience, the retailer estimates that 10% of the goods will be returned.
  • The cost of goods sold for each unit is $30.
  • The retailer has a 30-day return policy and incurs a $2 processing fee for each returned unit.

Step-by-Step Analysis:

  1. Determine the Transaction Price:
    The transaction price is the total consideration less the expected returns.

    • Total Consideration: 1,000 units × $50 = $50,000.
    • Expected Returns: 10% of 1,000 units = 100 units.
    • Expected Revenue from Kept Goods: (1,000 - 100) units × $50 = $45,000.

  2. Revenue Recognition at Sale:

    • Revenue: $45,000.
    • Refund Liability: The amount expected to be refunded for the 100 units × $50 = $5,000.

  3. Cost of Goods Sold and Return Asset:

    • Cost of Goods Sold for Kept Goods: (1,000 - 100) units × $30 = $27,000.
    • Return Asset for Expected Returns:
      Cost of Returned Goods = 100 units × $30 = $3,000.
      Less Expected Costs to Recover = 100 units × $2 = $200.
      Net Return Asset: $3,000 - $200 = $2,800.

  4. Journal Entries at the Time of Sale:

    • To record the sale and expected returns: 
      Dr Cash $50,000  
Cr Revenue $45,000  
Cr Refund Liability $5,000
    • To record the cost of goods sold and the return asset: 
      Dr Cost of Goods Sold $27,000  
Dr Return Asset $2,800  
Cr Inventory $30,000

  5. Subsequent Adjustments (if actual returns differ):
    If 110 units are ultimately returned (instead of the 100 initially estimated), the retailer adjusts the refund liability and return asset. For the extra 10 returned units:

    • Additional Refund Liability: 10 × $50 = $500.
    • Adjustment to Return Asset: 10 × ($30 - $2) = $280.

    The entity would:

    • Increase the refund liability by $500.
    • Increase the return asset by $280.
    • Reduce recognised revenue by $500, and adjust cost of goods sold accordingly.

Summary of Key Points

  • Under IFRS 15, revenue is recognised only for goods not expected to be returned.
  • A refund liability is recorded for expected returns, representing the obligation to refund customers.
  • A return asset is recognised, measured at the carrying amount of the inventory adjusted for any costs to recover the goods.
  • The transaction price is constrained by the expected returns, ensuring that recognised revenue reflects the amount the entity is reasonably assured to retain.
  • Adjustments are made as actual returns deviate from initial estimates, ensuring that revenue, liabilities, and assets remain accurate over time.

This approach ensures that the financial statements reflect a realistic view of revenue earned and liabilities incurred, aligning with IFRS 15’s overarching principles of reliable measurement and faithful representation.