A retailer sells inventory to customers with a 30-day money-back guarantee that qualifies as a right of return under ASC 606. Based on extensive historical experience, the retailer can reasonably estimate that 5% of units sold in a given period will be returned. Under ASC 606-10-55-23 through 55-25, how should the retailer account for these sales at the time control of the goods transfers to customers?
- Recognize revenue for the full sales price of all units sold, and separately recognize a warranty expense accrual for the estimated 5% of units expected to be returned
- Recognize revenue only for the 95% of units not expected to be returned, and recognize no liability or asset at all relating to the remaining 5% until an actual return occurs
- Recognize revenue for the consideration expected from the 95% of units expected to remain sold, recognize a refund liability for the consideration expected to be refunded on the estimated 5% of returns, and recognize a separate asset for the right to recover the returned product, measured at the former carrying amount of the inventory less expected costs to recover it and any expected decrease in value
- Recognize revenue for the full sales price of all units sold and reduce revenue by an allowance for returns only in the period in which actual returns occur
Why C? And why not the others?
Correct answer: C. Recognize revenue for the consideration expected from the 95% of units expected to remain sold, recognize a refund liability for the consideration expected to be refunded on the estimated 5% of returns, and recognize a separate asset for the right to recover the returned product, measured at the former carrying amount of the inventory less expected costs to recover it and any expected decrease in value
ASC 606-10-55-23 through 55-25 requires that when a product is sold with a right of return, the entity recognize revenue only for the consideration it expects to be entitled to keep, which excludes the amount attributable to expected returns; the entity separately recognizes a refund liability, measured at the amount of consideration received or receivable that it does not expect to keep, and a corresponding asset for its right to recover the returned product, measured at the former carrying amount of the inventory less the expected costs of recovery and any expected decrease in value from the return. The option that recognizes revenue on 100% of units and layers a warranty expense accrual on top misapplies warranty guidance to a fact pattern that is about a customer's unconditional right to send goods back, not about product defects. The option that excludes the 5% from revenue but records no asset or liability ignores that the standard specifically requires both a refund liability and a return asset to be recognized at the time of sale, not left unrecorded until an actual return happens. The option deferring any reduction in revenue until returns actually occur contradicts the core principle that expected returns must be estimated and excluded from revenue at the point control transfers, precisely because the retailer has sufficient historical data to make that estimate reliably.
Source: FASB Accounting Standards Codification: ASC 606-10-55-23 through 55-25, Revenue from Contracts with Customers — Rights of Return