7/30/2019 revenue recognition and sales returns.docx
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Sales return is the return of merchandise by a customer. In
accordance with generally accepted
accounting principles, when a buyer has a right to return a
product in the future in accordancewith formal or informal
agreement, a seller may or may not be able to recognize revenue at
the
time of sale.
The seller can record the sales revenue at the time of sale if
the seller can estimate the rate of
product returns (and meet some other requirements see below).
The estimated product return
allowances should be recorded at the time of sale as well.
However, 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 return
privilege expires.
Examples of factors that might preclude making a reasonable
estimate of product returns include:
A lengthy period for product returns (i.e., in accordance with a
product return policy) Lack of experience with product returns
(e.g., new product, new market) Few significant sales with unique
terms Product susceptibility to obsolescence Newness of the product
Introduction of new products which could lead to the high returns
of current products Introduction of superior products by
competitor(s) Channel stuffing (significant inventory level
increases in distribution channels)
If the returned merchandise has been used or has deteriorated,
such products should be recorded
at their net realizable value that depends on the present
condition of the products and costsincurred to make them ready for
resale. Loss on damaged returned inventory should be
recognized as well.
In addition to the lack of ability to reasonably estimate the
amount of future product returns,
there may be other conditions precluding a company from
recognizing revenue at the time
of sale when a right of product return exists:
The seller's price to the buyer is substantially 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 resellsthe product, then this condition is
not met.
The buyer's obligation to the seller would not be changed in the
event of theft or physicaldestruction or damage of the product.
The buyer acquiring the product for resale has economic
substance apart from thatprovided 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
