Refund liabilities

Refund liabilities – An entity may receive consideration that it will need to refund to the customer in the future because the consideration is not an amount to which the entity ultimately will be entitled under the contract. These amounts received (or receivable) needs to be recorded as refund liabilities.

A refund liability is measured at the amount the entity ultimately expects it will have to return to the customer and such amount is not included in the transaction price. An entity is required to update its estimates of refund liabilities (and the corresponding change in the transaction price) at the end of each reporting period.

While the most common form of refund liabilities may be related to sales with a right of return (see separate section ‘Right of return’), the refund liability requirements also apply when an entity expects that it will need to refund consideration received due to poor customer satisfaction with a service provided (i.e., there was no good delivered or returned) and/or if an entity expects to have to provide retrospective price reductions to a customer (e.g., if a customer reaches a certain threshold of purchases, the unit price is retrospectively adjusted).

Example – WatchCoRefund liabilities

  • WatchCo uses a wholesale network to supply its products to end customers.
  • WatchCo sells 100 watches to a retailer for €50 each. The cost of each watch is €10.
  • WatchCo estimates, based on the expected value method , that 6 % of watches sold will be returned, and it is highly probable that returns will not be higher than 6%.
  • WatchCo has no further obligations after transferring control of the watches.
Something else -   Consignment arrangements under IFRS 15

Situation A
Retailer has a contractual right to return the watches for a full refund for a contractually defined period.

Situation B
Retailer has no contractual right, but WatchCo has a customary business practice where returns have been made and accepted.

How should WatchCo recognise revenue in accordance with IFRS 15?

Here are the rules:

IFRS 15 10:

“A contract is an agreement between two or more parties that creates enforceable rights and obligations. Enforceability of the rights and obligations in a contract is a matter of law. Contracts can be written, oral or implied by an entity’s customary business practices. The practices and processes for establishing contracts with customers vary across legal jurisdictions, industries and entities […]. An entity shall consider those practices and processes in determining whether and when an agreement with a customer creates enforceable rights and obligations”

A right of return is not a separate performance obligation, but it affects the estimated transaction price for transferred goods. Revenue is only recognised 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.

  1. The estimate should reflect the amount that the entity expects to repay or credit customers, using either the expected value method or the most likely amount method.
  2. The transaction price should include amounts subject to return only if it is highly probable that there will not be a significant reversal of cumulative revenue if the estimate of expected returns change.

IFRS 15 B21 requires entities to account for sales with a right of return recognising 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
Something else -   Firm commitment
Situation A Situation B
Revenue is recognised when the watches are delivered and a liability deducted from revenue for expected returns. Simultaneously , an asset is recognised for the watches expected to be returned, reducing the cost of sales. Recognition occurs on transfer of control to the wholesaler.

The returns asset will be presented and assessed for impairment separately from the refund liability. WatchCo will need to assess the returns asset for impairment, and adjust the value of the asset if it is impaired.

Revenue: Sales price per unit × units (excluding those expected to be returned)
€50 × 100*(1 0.06 ) watches = 4,700
Cost of sales: Cost × units (excluding those expected to be returned)
€10 × 94 watches = 940
Asset: Former carrying amount x units expected to be returned
€10 × 6 watches = €60
Refund liability: Return ratio x units sold x sales price per unit
6% x 100 watches × €50 = €300 for the refund obligation .

WatchCo has a customary business practice of accepting returns which should be considered part of the terms of the contracts with its customers.

The right of return is accounted for in the same manner as in situation A.

Refund liabilities

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Refund liabilities

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General model of measurement of insurance contracts

Refund liabilities

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Something else -   Firm commitment

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