Right of return

Right of return – IFRS 15 notes that, in some contracts, an entity may transfer control of a product to a customer, but grant the customer the right to return. In return, the customer may receive a full or partial refund of any consideration paid; a credit that can be applied against amounts owed, or that will be owed, to the entity; another product in exchange; or any combination thereof [IFRS15 B20]. IFRS 15 B22 states that a right of return does not represent a separate performance obligation. Instead, a right of return affects the transaction price and the amount of revenue an entity can recognise for satisfied performance obligations. In other words, rights of return create variability in the transaction price. Right of return Right of return Right of return Right of return

Under IFRS 15, rights of return do not include exchanges by customers of one product for another of the same type, quality, condition and price (e.g., one colour or size for another). Nor do rights of return include situations where a customer may return a defective product in exchange for a functioning product; these are, instead, evaluated in accordance with the application guidance on warranties (see ‘Warranties‘).

The standard provides application guidance to determine how rights of return would be treated in IFRS 18 B21.

Under the standard, an entity estimates the transaction price and applies the constraint to the estimated transaction price to determine the amount of consideration to which the entity expects to be entitled. In doing so, it considers the products expected to be returned in order to determine the amount to which the entity expects to be entitled (excluding consideration for the products expected to be returned). The entity recognises revenue based on the amount to which it expects to be entitled through to the end of the return period (considering expected product returns). An entity does not recognise the portion of the revenue subject to the constraint until the amount is no longer constrained, which could be at the end of the return period. The entity recognises the amount received or receivable that is expected to be returned as a refund liability, representing its obligation to return the customer’s consideration (see ‘Refund liabilities‘). Subsequently, at the end of each reporting period, the entity updates its assessment of amounts for which it expects to be entitled.

As part of updating its estimate, an entity must update its assessment of expected returns and the related refund liabilities. This remeasurement is performed at the end of each reporting period and reflects any changes in assumptions about expected returns. Any adjustments made to the estimate result in a corresponding adjustment to amounts recognised as revenue for the satisfied performance obligations (e.g., if the entity expects the number of returns to be lower than originally estimated, it would have to increase the amount of revenue recognised and decrease the refund liability).

Finally, when customers exercise their rights of return, the entity may receive the returned product in a saleable or repairable condition. Under the standard, at the time of the initial sale (i.e., when recognition of revenue is deferred due to the anticipated return), the entity recognises a return asset (and adjusts the cost of goods sold) for its right to recover the goods returned by the customer.

The entity initially measures this asset at the former carrying amount of the inventory, less any expected costs to recover the goods, including any potential decreases in the value of the returned goods. Along with remeasuring the refund liability at the end of each reporting period, the entity updates the measurement of the asset recorded for any revisions to its expected level of returns, as well as any additional decreases in the value of the returned products.

IFRS 15 requires the carrying value of the return asset to be presented separately from inventory and to be subject to impairment testing on its own, separately from inventory on hand. The standard also requires the refund liability to be presented separately from the corresponding asset (on a gross basis, rather than a net basis).

The standard provides an example of rights of return see link [IFRS 15IE 110 – IFRS 15IE 115).

What’s changed from legacy IFRS?

While IFRS 15’s accounting treatment for rights of return may not significantly change practice from legacy IFRS, there are some notable differences. Under IFRS 15, an entity estimates the transaction price and apply the constraint to the estimated transaction price. In doing so, it considers the products expected to be returned in order to determine the amount to which the entity expects to be entitled (excluding the products expected to be returned).

Consistent with IAS 18.17, IFRS 15 requires an entity to recognise the amount of expected returns as a refund liability, representing its obligation to return the customer’s consideration. If the entity estimates returns and applies the constraint, the portion of the revenue that is subject to the constraint is not recognised until the amounts are no longer constrained, which could be at the end of the return period.

The classification in the statement of financial position for amounts related to the right of return asset may be a change from previous practice. Under legacy IFRS, an entity typically recognised a liability and corresponding expense, but may not have recognised a return asset for the inventory that may be returned, as is required by IFRS 15. In addition, IFRS 15 is clear that the carrying value of the return asset (i.e., the product expected to be returned) is subject to impairment testing on its own, separately from the inventory on hand. IFRS 15 also requires the refund liability to be presented separately from the corresponding asset (on a gross basis, rather than a net basis).

Consideration

The topic of product sales with rights of return is one that has not received as much attention as other topics for a variety of reasons. However, the changes in this area (primarily treating the right of return as a type of variable consideration to which the variable consideration requirements apply, including the constraint) may affect manufacturers and retailers that, otherwise, would not be significantly affected by IFRS 15. Entities need to assess whether their previous methods for estimating returns are appropriate, given the need to consider the constraint.

General model of measurement of insurance contracts

Right of return

Right of return

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