Many reporting entities offer their customers a right to return products they purchase. Return privileges can take many forms, including:
  • The right to return products for any reason
  • The right to return products if they become obsolete
  • The right to rotate stock
  • The right to return products upon termination of an agreement

Some of these rights are explicit in the contract, while others are implied. Implied rights can arise from statements or promises made to customers during the sales process, statutory requirements, or a reporting entity's customary business practice. These practices are generally driven by the buyer's desire to mitigate risk (risk of dissatisfaction, technological risk, or the risk that a distributor will not be able to sell the products) and the seller's desire to ensure customer satisfaction.
A right of return often entitles a customer to a full or partial refund of the amount paid or a credit against the value of previous or future purchases. Some return rights only allow a customer to exchange one product for another. Understanding the rights and obligations of both parties in an arrangement when return rights exist is critical to determining the accounting.
A customer’s right to require the seller to repurchase a good is a put right that should be evaluated under the repurchase right guidance (refer to RR 8.7.2). Under that guidance, if the customer does not have a significant economic incentive to exercise its right, the arrangement is generally accounted for as a sale with a right of return.
A right of return is not a separate performance obligation, but it affects the estimated transaction price for transferred goods. Revenue is only recognized for those goods that are not expected to be returned.
The estimate of expected returns should be calculated in the same way as other variable consideration. The estimate should reflect the amount that the reporting entity expects to repay or credit customers, using either the expected value method or the most-likely amount method, whichever management determines will better predict the amount of consideration to which it will be entitled. See RR 4 for further details about these methods. The transaction price should include consideration allocated to goods subject to return only if it is probable that there will not be a significant reversal of cumulative revenue if the estimate of expected returns changes.
It could be probable that some, but not all, of the variable consideration will not result in a significant reversal of cumulative revenue recognized. The reporting entity must consider, as illustrated in Example RR 8-1 and also in Example 22 in the revenue standard (ASC 606-10-55-202 through ASC 606-10-55-207), whether there is some minimum amount of revenue that would not be subject to significant reversal if the estimate of returns changes. Management should consider all available information to estimate its expected returns.
Right of return – sale of products to a distributor
Producer utilizes a distributor network to supply its product to end consumers. Producer allows distributors to return any products for up to 120 days after the distributor has obtained control of the products. Producer has no further obligations with respect to the products and distributors have no further return rights after the 120-day period. Producer is uncertain about the level of returns for a new product that it is selling through the distributor network.
How should Producer recognize revenue in this arrangement?
Producer must consider the extent to which it is probable that a significant reversal of cumulative revenue will not occur from a change in the estimate of returns. Producer needs to assess, based on its historical information and other relevant evidence, if there is a minimum level of sales for which it is probable there will be no significant reversal of cumulative revenue, as revenue needs to be recorded for those sales.
For example, if at inception of the contract Producer estimates that including 70% of its sales in the transaction price will not result in a significant reversal of cumulative revenue, Producer would record revenue for that 70%. Producer will need to update its estimate of expected returns at each period end.

The revenue standard requires reporting entities to account for sales with a right of return as follows.

ASC 606-10-55-23

To account for the transfer of products with a right of return (and for some services that are provided subject to a refund), an entity should recognize all of the following:

  1. Revenue for the transferred products in the amount of consideration to which the entity expects to be entitled (therefore, revenue would not be recognized for the products expected to be returned)
  2. A refund liability
  3. An asset (and corresponding adjustment to cost of sales) for its right to recover products from customers on settling the refund liability.

The refund liability represents the amount of consideration that the reporting entity does not expect to be entitled to because it will be refunded to customers. The refund liability is remeasured at each reporting date to reflect changes in the estimate of returns, with a corresponding adjustment to revenue.
The asset represents the reporting entity’s right to receive goods (inventory) back from the customer. The asset is initially measured at the carrying amount of the goods at the time of sale, less any expected costs to recover the goods and any expected reduction in value. In some instances, the asset could be immediately impaired if the reporting entity expects that the returned goods will have diminished or no value at the time of return. For example, this could occur in the pharmaceutical industry when product is expected to have expired at the time of return.
The return asset is presented separately from the refund liability. The amount recorded as an asset should be updated whenever the refund liability changes and for other changes in circumstances that might suggest an impairment of the asset. Example RR 8-2 illustrates this accounting treatment.
Right of return – refund obligation and return asset
Game Co sells 1,000 video games to Distributor for $50 each. Distributor has the right to return the video games for a full refund for any reason within 180 days of purchase. The cost of each game is $10. Game Co estimates, based on the expected value method, that 6% of sales of the video games will be returned and it is probable that returns will not be higher than 6%. Game Co has no further obligations after transferring control of the video games.
How should Game Co record this transaction?
Game Co should recognize revenue of $47,000 ($50 x 940 games) and cost of sales of $9,400 ($10 x 940 games) when control of the games transfers to Distributor. Game Co should also recognize an asset of $600 ($10 x 60 games) for expected returns, and a liability of $3,000 (6% of the sales price) for the refund obligation.
The return asset will be presented and assessed for impairment separate from the refund liability. Game Co will need to assess the return asset for impairment, and adjust the value of the asset if it becomes impaired.

Question RR 8-1
Is a reporting entity’s measurement of the refund liability affected if the customer is only entitled to a partial refund of the purchase price upon return of a product?
PwC response
Yes. If the reporting entity’s return policy permits customers to return products for a partial refund, the reporting entity should record a refund liability that reflects the portion of the transaction price expected to be refunded. The remaining transaction price (that is not expected to be refunded) is recognized when control of the product transfers to the customer. Refer to RR 8.2.2 for discussion of arrangements in which the customer is required to pay restocking fees when a product is returned.
Question RR 8-2
Are refund liabilities subject to the same presentation and disclosure guidance as contract liabilities?
PwC response
No. The revenue standard defines a “contract liability” as an obligation to transfer goods or services to a customer. A refund liability is an obligation to transfer cash. Therefore, refund liabilities do not meet the definition of a contract liability. While the revenue standard requires contract assets and contract liabilities arising from the same contract to be offset and presented as a single asset or liability, it does not provide presentation guidance for refund liabilities. The assessment of whether a refund liability may be offset against an asset arising from the same contract (for example, a contract asset or receivable) should be based on the offsetting guidance in ASC 210-20. Disclosures about obligations for returns and refunds are required as part of disclosures about performance obligations (refer to FSP 33.4).

8.2.1 Exchange rights

Some contracts allow customers to exchange one product for another.

Excerpt from ASC 606-10-55-28

Exchanges by customers of one product for another of the same type, quality, condition and price (for example, one color or size for another) are not considered returns

No adjustment of the transaction price is made for exchange rights. A right to exchange an item that does not function as intended for one that is functioning properly is a warranty, not a right of return. Refer to RR 8.3 for further information on accounting for warranties.

8.2.2 Restocking fees

Reporting entities sometimes charge customers a “restocking fee” when a product is returned to compensate the reporting entity for various costs associated with a product return. These costs can include shipping fees, quality control re-inspection costs, and repackaging costs. Restocking fees may also be charged to discourage returns or to compensate a reporting entity for the reduced selling price that a reporting entity will charge other customers for a returned product.

A product sale with a restocking fee is no different than a partial return right and should be accounted for similarly. For goods that are expected to be returned, the amount the reporting entity expects to repay its customers (that is, the estimated refund liability) is the consideration paid for the goods less the restocking fee. As a result, the restocking fee should be included in the transaction price and recognized when control of the goods transfers to the customer. An asset is recorded for the reporting entity’s right to recover the goods upon settling the refund liability. The reporting entity’s expected restocking costs should be recognized as a reduction of the carrying amount of the asset as they are costs to recover the goods. Refer to Revenue TRG Memo No. 35 and the related meeting minutes in Revenue TRG Memo No. 44 for further discussion of this topic.
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