Question

Codification Research Case

Employees at your company disagree about the accounting for sales returns. The sales manager believes that granting more generous return provisions can give the company a competitive edge and increase sales revenue. The controller cautions that, depending on the terms granted, loose return provisions might lead to non-GAAP revenue recognition. The company CFO would like you to research the issue to provide an authoritative answer.

(a)What is the authoritative literature addressing revenue recognition when right of return exists?

(b)What is meant by “right of return”? “Bill and hold”?

(c)Describe the accounting when there is a right of return.

(d)When goods are sold on a bill-and-hold basis, what conditions must be met to recognize revenue upon receipt of the order?

Answer 1

a)

The authoritative literature addressing revenue recognition when right of return exists is the FASB Codification Summary of Statement No. 48.B,

This Code specifies how an enterprise should account for sales of its product in which the buyer has a right to return the product. Revenue from those sales transactions shall be recognized at time of sale only if all of the conditions specified by the Statement are met. If those conditions are not met, revenue recognition is postponed; if they are met, sales revenue and cost of sales reported in the income statement shall be reduced to reflect estimated returns and expected costs or losses shall be accrued.

b)

Right of return is the return of products by a buyer. As per generally accepted accounting principles, when a buyer has a right to return a product in the future according to the agreement, a salesperson may or may not be able to recognize revenue at the time of sale.

Bill and hold is a way of performing sales by billing the customer on the same day the transaction occurs, However the delivery will take place in future date.

This is the transaction in which the seller does not deliver goods to the buyer, but still records the related revenue. However, revenue can only be recognized under this arrangement when a number of strict conditions have been met. Otherwise, there is a risk of falsely recognizing revenue too early.

c)

The vendor can record the sales revenue at the time of sale if the seller can estimate the rate of merchandise returns. The expected product return allowances should be recorded at the time of sale as well. Incase if the seller is unable to make a reasonable estimate of the amount of future product returns, the seller should wait to record revenue until the loss can be estimated or the right to return expires.

If the returned goods have been used or has deteriorated, such products need to be recorded at their net realizable value that depends on the present situation of the products and costs incurred to make them ready for resale. Loss on damaged returned stock should be recognized as well.

There may be other conditions preventing a company from recognizing revenue at the time of sale when a right of product return exists:

• The vendor's price to the buyer is considerably fixed or determinable at the date of sale.
• The buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on the resale of the product. If the buyer does not pay at time of sale and the buyer's obligation to pay is contractually or implicitly excused until the buyer resells the product, then this condition is not met.
• The buyer's commitment to the seller would not be changed in the event of theft or physical damage of the product.
• The buyer acquiring the product for resale has economic substance apart from that provided by the seller. This condition relates primarily to buyers that exist on paper; that is, buyers that have little or no physical facilities or employees. It prevents entities from recognizing sales revenue on transactions with parties that the sellers have established primarily for the purpose of recognizing such sales revenue.
• The seller does not have substantial responsibilities for future performance to directly bring about resale of the product by the buyer.

d)

The following conditions must be met in order for a bill-and-hold transaction to be recognized as revenue:

• Risks of ownership have passed to the customer.
• The customer has a fixed obligation to purchase the goods,
• The customer (not the seller) requested the transaction be on a bill-and-hold basis and the customer has a substantial business purpose for doing so.
• There is a fixed schedule for delivering the goods and the delivery date is reasonable.
• The vendor has no specific performance requirements such that the earnings process is not complete.
• The goods are separated from the seller’s regular inventory and cannot be used to fill other orders, and
• The good is complete and prepared for shipment.