Key points
- Customer rights to return products and extended warranties are accounted for under AASB 15
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Careful consideration of these are required as they impact the recognition of revenue, assets and liabilities
- Applying AASB 15 often involves significant judgement, and entities should seek expert advice for complex or unique circumstances.
Many inventory-based businesses offer customers a right to return products within a specified period, or to purchase additional warranties (over and above those required by law). This article considers how to account for products sold whereby customers have a right of return, and extended warranties, in accordance with AASB 15 Revenue from Contracts with Customers (AASB 15).
Right of return
Entities often allow customers a right of return, to return a product for a full or partial refund, a credit, or an exchange. Rights of return are a form of variable consideration, which require estimation in determining the transaction price.
Accounting guidance
To account for the transfer of products with a right of return (or services provided subject to a refund), an entity shall recognise all of the following:
- revenue for the transferred products in the amount of consideration to which the entity expects to be entitled. Revenue would not be recognised for the products expected to be returned;
- a refund liability; and
- an asset (and corresponding adjustment to cost of sales) for its right to recover products from customers on settling the refund liability. The value of the asset recorded would equate to the former carrying amount of the product (for example, inventory) less any expected costs to recover those products (including potential decreases in the value to the entity of returned product).
It’s important to note that:
- exchanges by customers of one product for another of the same type, quality, condition and price (for example, one colour or size for another) are not considered returns for the purposes of applying AASB 15.
- contracts in which a customer may return a defective product in exchange for a functioning product shall be evaluated in accordance with the guidance on warranties. We have considered warranties further below in this article.
Practical example
How should ArtCo recognise returns associated with these transactions? For the purpose of this scenario, ArtCo has considered the requirements in AASB 15.56-58 on constraining estimates of variable consideration to determine whether the estimated amount of variable consideration of $9,700 ($100 x 97 products not expected to be returned) can be included in the transaction price. Although the returns are outside of ArtCo’s influence, ArtCo has significant experience in estimating returns for this product and customer class. In addition, the uncertainty will be resolved within a short time frame (ie. 30 day return period). Thus, ArtCo concludes that it is highly probable that a significant reversal in the cumulative amount of revenue recognised (ie. $9,700) will not occur as the uncertainty is resolved (ie. over the return period). Upon transfer of control of the 100 paintings, ArtCo does not recognise revenue for the three products that it expects to be returned. Consequently, ArtCo recognises the following: |
| Account | Impact | Explanation |
| DR Cash | $10,000 | $100 x 100 products |
| CR Revenue | ($9,700) | $100 x 97 products not expected to be returned |
| CR Refund liability | ($300) | $100 refund x 3 products expected to be returned |
| DR Cost of Sales | $5,820 | $60 x 97 products not expected to be returned |
| CR Inventory | ($6,000) | $60 x 100 products |
| DR Asset | $180 | $60 x 3 products for its right to recover products from customers settling the refund liability |
[Based on Example 22 in International Financial Reporting Standard IFRS 15 Revenue from Contracts with Customers May 2014 Illustrative Examples (IFRS 15 Illustrative Examples)].
Warranties
Entities often provide warranties in connection with the sale of a product. Some warranties are required by law, and others are extended warranties which customers can purchase separately. The nature of these warranties differ widely. Entities should analyse these warranties to determine whether they result in a separate performance obligation under AASB 15.
It is important to note that warranties provided by a manufacturer, dealer or retailer in connection with the sale of its goods or services to a customer are outside of the scope of AASB 17 Insurance Contracts (AASB 17).
Accounting guidance
If a customer has the option to purchase a warranty separately (for example, because the warranty is priced or negotiated separately), the warranty is a distinct service because the entity promises to provide the service to the customer in addition to the product that has the functionality described in the contract. In those circumstances, an entity shall account for the promised warranty as a separate performance obligation and allocate a portion of the transaction price to that performance obligation. The entity would then allocate this transaction price to revenue over the period in which the service is provided.
If a customer does not have the option to purchase a warranty separately, an entity shall account for the warranty in accordance with AASB 137 Provisions, Contingent Liabilities and Contingent Assets (AASB 137) unless the promised warranty, or a part of the promised warranty, provides the customer with a service in addition to the assurance that the product complies with agreed-upon specifications, in which case the promised service is a performance obligation.
In assessing whether a warranty provides a customer with a service in addition to the assurance that the product complies with agreed-upon specifications, an entity shall consider factors such as:
- Whether the warranty is required by law – if the entity is required by law to provide a warranty, the existence of that law indicates that the promised warranty is not a performance obligation because such requirements typically exist to protect customers from the risk of purchasing defective products.
- The length of the warranty coverage period – the longer the coverage period, the more likely it is that the promised warranty is a performance obligation because it is more likely to provide a service in addition to the assurance that the product complies with agreed-upon specifications.
- The nature of the tasks that the entity promises to perform – if it is necessary for an entity to perform specified tasks to provide the assurance that a product complies with agreed-upon specifications (for example, a return shipping service for a defective product), then those tasks likely do not give rise to a performance obligation.
Where a warranty provision is recognised under AASB 137 the amount recognised as a provision shall be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period.
Practical example
How should RefrigeratorCo account for the warranties? The additional 3 year warranty is a separate performance obligation, and revenue should be recognised over the period for which the extended warranty service is provided. The costs of warranty repairs should be recorded when they are incurred as contract costs (costs to fulfil a contract). The 12 month warranty, as required by law, is accounted for in accordance with AASB 137 with a provision being recorded upon entering the contract for the estimated cost of repairs over the 12 month period. |
Summing up
Rights to return and warranties are common areas to consider for the retail sector, and other sectors involving the sale of goods. While the guidance above is provided for in AASB 15 and AASB 137, specific facts and circumstances can arise which may require significant judgement. Please reach out to us, or your local Pitcher Partners contact to discuss further if required.
