An example of how the IASB’s new IFRS 15 may generate greater complexity and transparency
As we summarized here, the IASB has issued IFRS 15, Revenue from Contracts with Customers, effective for annual reporting periods beginning on or after January 1, 2017 (NB this was subsequently amended to January 1, 2018). The standard is full of subtleties and complexities, and will require a fundamentally different approach to many aspects of accounting for revenue. The approach to sales with a right of return is just one of these areas, and also helps to illustrate the broader challenges of implementing the new standard.
Under the current approach in IAS 18, an entity typically reduces the amount of revenue it recognizes on a transaction to reflect an estimate for items that will be returned, but IAS 18 doesn’t say much about the mechanics of how to calculate and adjust that estimate. An entity might disclose in its accounting policy that (say) revenue from the sale of goods is measured at the fair value of the consideration received or receivable, net of returns and other relevant items, but it’s not likely to disclose any information about the amounts actually netted against revenues, or to indicate how its accounting policy might affect assets and liabilities at the end of any given reporting period. IFRS 15, in contrast, says this:
- “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 recognize 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 recognized 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.”
This makes the approach to this area much more explicit than before. Depending on the facts of an individual situation, and leaving aside all the other possible sources of differences, the amount of revenue recognized in this regard may be the same under the new standard as it was under the old one, reflecting what the entity expects to receive and keep from selling products that won’t be returned. However, the new standard clarifies that the obligation to provide refunds or credits or other compensation to customers who do return products meets the definition of a liability, just as much as anything else does. At the same time, once it’s provided that refund or credit to the customer, the entity’s right to recover its merchandise meets the definition of an asset.
Of course, these assets and liabilities may be subject to ongoing measurement uncertainty. At the end of each reporting period, the standard requires that an entity updates the assessment of amounts for which it expects to be entitled in exchange for the transferred products and makes a corresponding change to the transaction price and, therefore, to the amount of revenue it’s recognized. Similarly, the entity updates the measurement of the refund liability for changes in expectations about the amount of refunds, recognizing corresponding adjustments as revenue (or reductions of revenue).
It initially measures the asset “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).” Again, at the end of each reporting period, the entity updates the measurement of the asset for changes in expectations about products to be returned. The standard then requires disclosing “information about the methods, inputs and assumptions used in (among other things) measuring obligations for returns, refunds and other similar obligations.”
Clearly, for entities that customarily offer a right of return to their customers, this may require changes to existing systems and procedures, perhaps to bring greater formality to the process as a whole (it’s possible for some entities that this may have a broader benefit in causing them to re-examine aspects of their current policies). It’s likely, at least at first glance, that some affected entities may consider the new approach somewhat onerous. It’s instructive to note though that this represents a concession from what the standard, applying its usual five-step framework (examined in previous articles), might have required. The basis for conclusions to the standard sets out that the IASB and FASB considered whether the right to return constitutes a separate performance obligation provided by the entity, and should be subject to separate accounting (including estimating a stand-alone selling price for that service). It says:
- “Because, in many cases, the number of returns is expected to be only a small percentage of the total sales and the return period is often short (such as 30 days), the boards decided that the incremental information provided to users of financial statements by accounting for the return right service as a performance obligation would not have justified the complexities and costs of doing so. Consequently, the boards decided that the return right service should not be accounted for as a performance obligation.”
This likely provides an example of the meticulous thinking underlying the new standard, and of the dangers of assuming that any aspects of existing practice will remain acceptable after adopting IFRS 15…
The opinions expressed are solely those of the author