variable consideration to determine whether the estimated amount of variable consideration of CU9,700
(CU100 × 97 products not expected to be returned) can be included in the transaction price. The entity
considers the factors in paragraph 57 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 (i.e. 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. CU9,700) 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 100 products, the entity does not recognise revenue for the three products that
it expects to be returned. Consequently, in accordance with paragraphs 55 and B21 of IFRS 15, the entity
recognises the following:
• revenue of CU9,700 (CU100 × 97 products not expected to be returned);
• a refund liability of CU300 (CU100 refund × 3 products expected to be returned); and
• an asset of CU180 (CU60 × 3 products for its right to recover products from customers on settling the
refund liability).
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While IFRS 15’s accounting treatment for rights of return may not significantly change
previous practice from legacy IFRS, there are some notable differences. Under IFRS 15,
an entity estimates the transaction price and apply the constraint to the estimated
transaction price. In doing so, it considers the products expected to be returned in order
to determine the amount to which the entity expects to be entitled (excluding the
products expected to be returned). [IFRS 15.B23].
Consistent with paragraph 17 of IAS 18, IFRS 15 requires an entity to recognise the
amount of expected returns as a refund liability, representing its obligation to return the
customer’s consideration. [IFRS 15.B21, IAS 18.17]. If the entity estimates returns and applies
the constraint, the portion of the revenue that is subject to the constraint is not
recognised until the amounts are no longer constrained, which could be at the end of
the return period.
The classification in the statement of financial position for amounts related to the
right of return asset may be a change from previous practice. Under legacy IFRS, an
entity typically recognised a liability and corresponding expense, but may not have
recognised a return asset for the inventory that may be returned, as is required by
IFRS 15. In addition, IFRS 15 is clear that the carrying value of the return asset
(i.e. the product expected to be returned) is subject to impairment testing on its own,
separately from the inventory on hand. IFRS 15 also requires the refund liability to
be presented separately from the corresponding asset (on a gross basis, rather than
a net basis).
The topic of product sales with rights of return is one that has not received as much
attention as other topics for a variety of reasons. However, the changes in this area
(primarily treating the right of return as a type of variable consideration to which the
variable consideration requirements apply, including the constraint) may affect
manufacturers and retailers that, otherwise, would not be significantly affected by
IFRS 15. Entities need to assess whether their current methods for estimating returns
are appropriate, given the need to consider the constraint.
See 8.4.2.A for a discussion on whether a conditional call option held by an entity to
remove and replace expired products (e.g. out-of-date perishable goods, expired
medicine) prevents a customer from obtaining control of the products or is akin to a
right of return.
6.4.1
Is an entity applying the portfolio approach practical expedient when
accounting for rights of return?
An entity can, but would not be required to, apply the portfolio approach practical
expedient to estimate variable consideration for expected returns using the expected
value method. Similar to the discussion at 6.2.2 above on estimating variable
consideration, the July 2015 TRG agenda paper noted that an entity can consider
evidence from other, similar contracts to develop an estimate of variable consideration
using the expected value method without applying the portfolio approach practical
expedient. In order to estimate variable consideration in a contract, an entity frequently
makes judgements considering its historical experience with other, similar contracts.
Considering historical experience does not necessarily mean the entity is applying the
portfolio approach practical expedient.74
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This question arises, in part, because Example 22 in IFRS 15 (see Example 28.42
at 6.4 above) states that the entity is using the portfolio approach practical expedient in
paragraph 4 of IFRS 15 to calculate its estimate of returns. Use of this practical expedient
requires an entity to assert that it does not expect the use of the expedient to differ
materially from applying the standard to an individual contract.
We expect that entities often use the expected value method to estimate variable
consideration related to returns because doing so would likely better predict the amount
of consideration to which the entities will be entitled. This is despite the fact that there are
two potential outcomes for each contract from the variability of product returns: the
product either will be returned or will not be returned. That is, the revenue for each
contract ultimately either will be 100% or will be 0% of the total contract value (assuming
returns create the only variability in the contract). However, entities may conclude that the
expected value is the appropriate method for estimating variable consideration because
they have a large number of contracts with similar characteristics. The TRG agenda paper
noted that using a portfolio of data is not equivalent to using the portfolio approach
practical expedient, so entities that use the expected value method to estimate variable
consideration for returns would not be required to assert that the outcome from the
portfolio is not expected to materially differ from an assessment of individual contracts.
6.4.2
Accounting for restocking fees for goods that are expected to be returned
Entities sometimes charge customers a ‘restocking fee’ when a product is returned. This
fee may be levied by entities to compensate them for the costs of repackaging, shipping
and/or reselling the item at a lower price to another customer. Stakeholders had raised
questions about how to account for restocking fees and related costs.75
At the July 2015 TRG meeting, the TRG members generally agreed that restocking fees
for goods that are expected to be returned would be included in the estimate of the
transaction price at contract inception and recorded as revenue when (or as) control of
the good transfers.
For example, assume that an entity enters into a contract with a customer to sell
10 widgets for �
�100 each. The customer has the right to return the widgets, but if it does
so, it will be charged a 10% restocking fee (or £10 per returned widget). The entity
estimates that 10% of all widgets that are sold will be returned. Upon transfer of control
of the 10 widgets, the entity will recognise revenue of £910 [(9 widgets not expected to
be returned × £100 selling price) + (1 widget expected to be returned × £10 restocking
fee)]. A refund liability of £90 will also be recorded [1 widget expected to be returned ×
(£100 selling price – £10 restocking fee)].
6.4.3
Accounting for restocking costs for goods that are expected to be
returned
At the July 2015 TRG meeting, the TRG members generally agreed that restocking costs
(e.g. shipping and repackaging costs) would be recorded as a reduction of the amount of
the return asset when (or as) control of the good transfers. This accounting treatment is
consistent with the revenue standard’s requirement that the return asset be initially
measured at the former carrying amount of the inventory, less any expected costs to
recover the goods (e.g. restocking costs).76
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6.5 Significant
financing
component
For some transactions, the receipt of the consideration does not match the timing of the
transfer of goods or services to the customer (e.g. the consideration is prepaid or is paid
after the services are provided). When the customer pays in arrears, the entity is
effectively providing financing to the customer. Conversely, when the customer pays in
advance, the entity has effectively received financing from the customer.
IFRS 15 states that ‘in determining the transaction price, an entity shall adjust the
promised amount of consideration for the effects of the time value of money if the
timing of payments agreed to by the parties to the contract (either explicitly or
implicitly) provides the customer or the entity with a significant benefit of financing the
transfer of goods or services to the customer. In those circumstances, the contract
contains a significant financing component. A significant financing component may exist
regardless of whether the promise of financing is explicitly stated in the contract or
implied by the payment terms agreed to by the parties to the contract.’ [IFRS 15.60].
The standard goes on to clarify that ‘the objective when adjusting the promised amount
of consideration for a significant financing component is for an entity to recognise
revenue at an amount that reflects the price that a customer would have paid for the
promised goods or services if the customer had paid cash for those goods or services
when (or as) they transfer to the customer (i.e. the cash selling price). An entity shall
consider all relevant facts and circumstances in assessing whether a contract contains a
financing component and whether that financing component is significant to the
contract, including both of the following:
(a) the difference, if any, between the amount of promised consideration and the cash
selling price of the promised goods or services; and
(b) the combined effect of both of the following:
(i) the expected length of time between when the entity transfers the promised
goods or services to the customer and when the customer pays for those
goods or services; and
(ii) the prevailing interest rates in the relevant market.’ [IFRS 15.61]
Notwithstanding this assessment, a contract with a customer would not have a
significant financing component if any of the following factors exist: [IFRS 15.62]
• the customer paid for the goods or services in advance and the timing of the
transfer of those goods or services is at the discretion of the customer;
• a substantial amount of the consideration promised by the customer is variable and
the amount or timing of that consideration varies on the basis of the occurrence or
non-occurrence of a future event that is not substantially within the control of the
customer or the entity (e.g. if the consideration is a sales-based royalty); or
• the difference between the promised consideration and the cash selling price of the
good or service (as described in (a) above) arises for reasons other than the provision
of finance to either the customer or the entity, and the difference between those
amounts is proportional to the reason for the difference. For example, the payment
terms might provide the entity or the customer with protection from the other party
failing to adequately complete some or all of its obligations under the contract.
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This assessment may be difficult in some circumstances, so the Board provided a practical
expedient. An entity ‘need not adjust the promised amount of consideration for the effects
of a significant financing component if the entity expects, at contract inception, that the
period between when the entity transfers a promised good or service to a customer and
when the customer pays for that good or service will be one year or less.’ [IFRS 15.63].
When an entity concludes that a financing component is significant to a contract, it
determines the transaction price by discounting the amount of promised consideration.
The entity uses the same discount rate that it would use if it were to enter into a separate
financing transaction with the customer at contract inception. The discount rate has to
reflect the credit characteristics of the borrower in the contract, as well as any collateral
or security provided by the customer or the entity, including assets transferred in the
contract. The standard notes that an entity ‘may be able to determine that rate by
identifying the rate that discounts the nominal amount of the promised consideration to
the price that the customer would pay in cash for the goods or services when (or as)
they transfer to the customer.’ The entity does not update the discount rate for changes
in circumstances or interest rates after contract inception. [IFRS 15.64].
The Board explained in the Basis for Conclusions that, conceptually, a contract that
includes a financing component is comprised of two transactions – one for the sale of
goods and/or services and one for the financing. [IFRS 15.BC229]. Accordingly, the Board
decided to only require entities to adjust the amount of promised consideration for the
effects of financing if the timing of payments specified in the contract provides the
customer or the entity with a significant benefit of financing. The IASB’s objective in
requiring entities to adjust the promised amount of consideration for the effects of a
significant financing component is for entities to recognise as revenue the ‘cash selling
price’ of the underlying goods or services at the time of transfer. [IFRS 15.BC230].
However, an entity is not required to adjust the promised amount of consideration for the
effects of a significant financing component if the entity expects, at contract inception, that
the period between when the entity transfers a promised good or service to a customer
and when the customer pays for that good or service will be one year or less. The Board
added this practical expedient to the standard because it simplifies the application of this
aspect of IFRS 15 and because the effect of accounting for a significant financing
component (or of not doing so) should be limited in financing arrangements with a duration
of less than 12 months. [IFRS 15.BC236]. If an entity uses this practical expedient, it would
apply the expedient consistently to similar contracts in similar circumstances. [IFRS 15.BC235].
It is important to note that if the period between when the entity transfers a promised
good or service to a customer and the customer pays for that good or service is more than
one year and the financing component is deemed to be significant, the entity must account
for the entire financing component. That is, an entity cannot exclude the first 12 months
of the period between when the entity transfers a promised good or service to a customer
and when the customer pays for that good or service from the calculation of the potential
adjustment to the transaction price. An entity also cannot exclude the first 12 months in
its determination of whether the financing component of a contract is significant.
Entities may need to apply judgement to determine whether the practical expedient
applies to some contracts. For example, the standard does not specify whether entities
should assess the period between payment and performance at the contract level or at
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the performance obligation level. In addition, the TRG discussed how an entity should
consider whether the practical expedient applies to contracts with a single payment
stream for multiple performance obligations. See 6.5.2.D below.
Absent the use of the practical expedient, to determine whether a significant financing
component exists, an entity needs to consider all relevant facts and circumstances, including:
(1) the difference between the cash selling price and the amount of promised
consideration for the promised goods or services; and
(2) the combined effect of the expected length of time between the transfer of the goods
or services and the receipt of consideration and the prevailing market interest rates.
The Board acknowledged that a difference in the timing between the transfer of and
payment for goods or services is not determinative, but the combined effect of timing
and the prevailing interest rates may provide a strong indication that an entity is
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 420
