Question

Why does GAAP require companies to record estimated sales returns to be made in the subsequent period, if material? What entry is made to do this?

Answer 1

IFRS 15 defines a right to return(i.e estimated sales return) as a right that enables a customer to receive:

1. A full or partial refund of any consideration paid
2. A credit that can be applied against other amounts owed, or that will be owed, to the vendor by the customer
3. A different product in exchange, or
4. Any combination of the above.

Where a right to return exists, IFRS 15 requires sales revenue to be reduced to reflect the expected value of returns using the rules relating to variable consideration. Instead of recognising revenue for these expected returns, a refund liability is recognised. The inventory cost of items expected to be returned are also excluded from cost of sales and instead remain within inventory.

For example,

A retailer sells 10 items for $150, with a cost per item of $75 which results in a margin of $75 per item. Retailer anticipates that 2 of these items will be returned for a cash refund or exchanged for a different item.

Now,

Entry flow working will be

Revenue	1,200.00	(10-2) x 150
Cost of Sales	600.00	(10-2) x 75
Gross Profit	600.00
Inventories	150.00	(2 x 75)
Refund liability	300.00	(2 x 150)

Entry will be

Entry Flow
Sr No	Particulars	Debit	Credit
1(a)	Account Receivables	1,500.00
	To Revenue		1,500.00
1(b)	Cost of Goods Sold A/c	750.00
	To Inventory A/c		750.00
2(a)	Revenue	300.00
	To Account Receivable(Refund Liability)		300.00
2(B)	Inventory A/c (Right of Return)	150.00
	To Cost of Goods Sold (on Estimated Returns)		150.00

Thanks