Question

1. Kidlet Toys Ltd. designs and manufactures toys for the early childhood education market. The company sells its products to national toy retailers as well as to independent toy stores across North America. The company allows its customers to return any unsold products within 90 days of receiving the products from Kidlet. The rationale for this policy is to stimulate sales, especially among the independent toy stores. Returned toys are discarded.

Explain when Kidlet would recognize revenue under the contract-based approach. Also explain what the company would have to do to determine the amount of revenue that could be recognized.

Answer 1

As per IFRS 15 the Kidlet Toys Ltd. should recognise the revenue only when the return period of 90 days is completed until that time the entity shall not be recognised

How to recognise the revenue could be understood with the following example

QUESTION

An entity enters into 1,000 contracts with customers. Each contract includes the sale of one product for ` 50 (1,000 total products × ` 50 = ` 50,000 total consideration). Cash is received when control of a product transfers. The entity's customary business practice is to allow a customer to return any unused product within 30 days and receive a full refund. The entity's cost of each product is ` 30. The entity applies the requirements in IFRS 15 to the portfolio of 1,000 contracts because it reasonably expects that, in accordance with paragraph 4, the effects on the financial statements from applying these requirements to the portfolio would not differ materially from applying the requirements to the individual contracts within the portfolio.Since the contract allows a customer to return the products, the consideration received from the customer is variable. To estimate the variable consideration to which the entity will be entitled, the entity decides to use the expected value method (see paragraph 53(a) of IFRS 15) because it is the method that the entity expects to better predict the amount of consideration to which it will be entitled. Using the expected value method, the entity estimates that 970 products will not be returned.The entity estimates that the costs of recovering the products will be immaterial and expects that the returned products can be resold at a profit.Determine the amount of revenue, refund liability and the asset to be recognised by the entity for the said contracts.

SOLUTION

The entity also considers the requirements in paragraphs 56–58 of IFRS 15 on constraining estimates of variable consideration to determine whether the estimated amount of variable consideration of ` 48,500 (` 50 × 970 products not expected to be returned) can be included in the transaction price. The entity considers the factors of IFRS 15 and determines that although the returns are outside the entity's influence, it 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 the 30-day return period). Thus, the entity concludes that it is highly probable that a significant reversal in the cumulative amount of revenue recognised (i.e.` 48,500) will not occur as the uncertainty is resolved (i.e. over the return period). The entity estimates that the costs of recovering the products will be immaterial and expects that the returned products can be resold at a profit.

Upon transfer of control of the 1,000 products, the entity does not recognise revenue for the 30 products that it expects to be returned. Consequently, in accordance with paragraphs 55 and B21 of IFRS 15, the entity recognises the following:

(a) revenue of ` 48,500 (` 50 × 970 products not expected to be returned);

(b) a refund liability of ` 1,500 (` 50 refund × 30 products expected to be returned); and

(c)an asset of ` 900 (` 30 × 30 products for its right to recover products from customers on settling the refund liability).

Provision As per IFRS 15:

In some contracts, an entity transfers control of a product to a customer and also grants the customer the right to return the product for various reasons (such as dissatisfaction with the product) and receive any combination of the following:

(a) a full or partial refund of any consideration paid;

(b) a credit that can be applied against amounts owed, or that will be owed, to the entity; and

(c) another product in exchange. IFRS 15 clarifies that in some contracts, an entity transfers control of a product to a customer with an unconditional right of return. In such cases, the recognition of revenue shall be as per the substance of the arrangement. Where the substance is that of a consignment sale, the entity shall account for such a contract as per the provisions of IFRS 15’s application guidance related to consignment sales of Application Guidance to IFRS 15. In other cases, the accounting for contracts with customers shall be as per provisions laid out below. To account for the transfer of products with a right of return (and for some services that are provided subject to a refund), an entity shall recognise all of the following:

(a) revenue for the transferred products in the amount of consideration to which the entity expects to be entitled (therefore, revenue would not be recognised for the products expected to be returned);

(b) a refund liability; and

(c) an asset (and corresponding adjustment to cost of sales) for its right to recover products from customers on settling the refund liability. An entity’s promise to stand ready to accept a returned product during the return period shall not be accounted for as a performance obligation in addition to the obligation to provide a refund. An entity shall apply the requirements IFRS 15(including the requirements for constraining estimates of variable consideration ) to determine the amount of consideration to which the entity expects to be entitled (i.e. excluding the products expected to be returned). For any amounts received (or receivable) for which an entity does not expect to be entitled, the entity shall not recognise revenue when it transfers products to customers but shall recognise those amounts received (or receivable) as a refund liability. Subsequently, at the end of each reporting period, the entity shall update its assessment of amounts for which it expects to be entitled in exchange for the transferred products and make a corresponding change to the transaction price and, therefore, in the amount of revenue recognised. An entity shall update the measurement of the refund liability at the end of each reporting period for changes in expectations about the amount of refunds. An entity shall recognise corresponding adjustments as revenue (or reductions of revenue). An asset recognised for an entity’s right to recover products from a customer on settling a refund liability shall initially be measured by reference 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 products). At the end of each reporting period, an entity shall update the measurement of the asset arising from changes in expectations about products to be returned. An entity shall present the asset separately from the refund liability.

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 this Standard