IFRS 115/IND AS 115 — Revenue from Contracts with Customers — Sale with rights to return
As per IFRS/IND AS 115 (hereinafter — standard) revenue is recognized in a 5 step model approach.
1. Identity the contract with customer
2. Identify the performance obligations in a contract
3. Determine the Transaction price
4. Allocate Transaction price to the performance obligations
5. Recognize revenue as and when entity satisfies the performance obligations.
What happens when the sale has an element of RIGHT TO RETURN?
Let’s dive into it further :
Right to Return
I. Full or Partial
II. A credit that can be applied against amounts owed or that will be owed
III. Exchange of product
III. Exchange of Product
-If the exchange is of same type,quality and price.
-It is not considered as right to return by the standard IFRS/IND AS 115
#Initial Accounting for I & II
A. Revenue Recognition
a) Amount = Gross Transaction Price — revenue related to expected level of returns
b) It is the amount that entity expects to be ENTITLED through the sale of product in a nutshell
B. Liability Recognition for refund
a) Amount = Revenue related to Expected level of returns
b) It is the amount that entity has to pay back to customer in case the product is returned
c) Hence it is recognized as liability at inception and not as revenue
C. Asset/Inventory adjustment
a) Amount = cost related to expected level of returns
b) It is the amount of inventory that entity expects to be returned
#Subsequent Accounting for I & II
A. Revenue Recognition
No Change
B. Liability Recognition for refund
a) Update each reporting period — adjustments to revenue
b) Why adjustment to revenue — Because while our initial entry we have adjusted revenue by this amount. Hence, any change in this figure should also go into revenue account.
C. Asset/Inventory adjustment
a) Update each reporting period — adjustments to expense
b) Why expense — Because while our initial entry we have adjusted expense(COGS) by this amount. Hence, any change in this figure should also go into COGS
In a simple way to understand,
-Revenue Is recognized only for products that entity expects will not be returned and hence the COGS is also recognized related to it
-A liability is created for the rest of the product which is sold but which are still expected to be returned
-As, the remaining inventory are still lying in the stock. Hence, the same is removed from inventory and showed as “Other Asset” so that once the product is returned same can be shown under stock again
Let’s go through one example to understand it:
Product/No. of items — 1000
Price — 10
Cost — 5
Return policy — 30 Days
Expected Return — 40
Actual Return — 35
Initial Entries
1 Customer Dr 10,000
Revenue Cr 9,600 (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)
Liability Cr 400
2. Asset Dr 200 (an asset (and corresponding adjustment to cost of sales) for its right to recover products from customers on settling the refund liability)
COGS Dr 4,800
Inventory Cr 5,000
Subsequent Entries
Within 30 days Product return
1.Liability Dr 350 (To recognize refund for the product return)
Cash/Customer Cr 350
2.Inventory Dr 175 (To recognize product returned as inventory)
Asset Cr 175
Post 30 days Right of return expires
1. Refund liability Dr 50 (To recognize revenue on expiry of right of return)
Revenue Cr 50
2. Cost of sales Dr 25 (To recognize cost of sales on expiry of right to recover products from customers)
Asset Cr 25
Importance : Your accounting will impact companies top line item directly. Hence, it is very very crucial aspects to ponder upon and formulate companies accounting policy accordingly.
Warning/Key Note :
1. Yes intentionally it is written warning, as it looks super simple while its application is very difficult. Huh, Why? Because it involves a lot of estimates and judgments. And due to the complexities of the current business model it is not easy to do these estimates and it also involves lot of off record/lengthy calculation and documentation on every reporting date.
2. On top of it here the adjustment is done to the top-line item and as we all know NO ONE LIKES its GROSS REVENUE TO BE ADJUSTMENT/SHOWN AT LESSER AMOUNT.😎
Thank you👍✔
