5.3.3: Sales With Right of Return

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It is a common practice in the retail sector to allow customers to return products for various reasons, within a certain period of time. When the product is returned, the customer may receive a full refund, a credit to be applied against future purchases, or a replacement product. The accounting issue for the company is whether the full amount of revenue should be recognized at the time of sale, given that a certain number of returns may be expected. The general approach used here is to record revenue only in the amount of consideration expected to be received. In other words, the company needs to make an estimate at the time of sale of the amount of returns expected, and then exclude this amount from reported revenue. This amount should be reported as a refund liability. As well, the company should report an asset equal to the expected amount of product to be returned. The asset would be adjusted against the cost of goods sold in the period of sale. At the end of every accounting period, the estimates used to arrive at the refund liability and asset should be reviewed and adjusted where necessary. It is expected that most companies should be able to make reasonable estimates of these amounts, using historical, industry, technical, or other data.

Consider the following example. Wyeth Mart sells high quality paintbrushes for use in fine art applications. Each brush costs the company $15 and sells for $25. Wyeth Mart offers a full refund for any unused product that is returned within 30 days of purchase, and the company expects that these returned products can resold for a profit. The company has reviewed historical sales data and estimated that 2% of products sold will be returned for a refund. During the month of May, 1,000 paintbrushes are sold for cash. The journal entries in May would be:

In June, if 20 brushes are returned, the journal entry will be:

If the amount returned differs from estimated amount, the refund liability and refund asset will need to be adjusted once the return period expires. This is an ongoing process, as most companies will continue to make new sales during the period. As a practical matter, many companies will only review the balances of the refund liability and refund asset account at the annual reporting date.

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