CHAPTER 5 Revenue Recognition and Profitability Analysis 247 (concluded) Bonus receivable ($180,000 3 3⁄6) ................................ 90,000 Service revenue ....................................................... 90,000 RIGHT OF RETURN. Retailers usually give customers the right to return merchandise if customers are not satisfied or are unable to resell it. For example, manufacturers of semiconductors like Motorola Corporation usually sell their products through independent distributor companies. Economic factors, competition among manufacturers, and rapid obsolescence of the product motivate these manufacturers to grant the distributors the right of return if they are unable to sell the semiconductors. The right to return merchandise does not create a performance obligation for the seller. Instead, it represents a potential failure to satisfy the original performance obligation to provide goods that the customer wants to keep. Because the total amount of cash received from the customer depends on the amount of returns, a right of return creates a situation involving variable consideration. Based on past experience, a seller usually can estimate the returns that will result for a given volume of sales, so the seller reduces revenue by the estimated returns and records a liability for cash the seller anticipates refunding to customers. For example, assume that TrueTech sold 1,000 Tri-Boxes to CompStores for $240 each. TrueTech would record the following entry: Cash ($240 3 1,000) ............................................................................. 240,000 Sales revenue .................................................................................. 240,000 Sales returns ($240,000 3 5% estimated returns) .................................. 12,000 Refund liability ................................................................................ 12,000 Bonus Receivable 1/1 -0- 3/31 90,000 4/30 30,000 5/31 30,000 6/30 30,000 6/30 180,000 Service Revenue 1/1 -0- 1/31 50,000 2/28 50,000 3/31 50,000 3/31 90,000 4/30 80,000 5/31 80,000 6/30 80,000 6/30 480,000 A right of return is not a performance obligation. have been recognized over the first three months of the contract if an estimate of variable consideration had been included in the transaction price to begin with: In the final three months of the contract, TrueTech recognizes the remaining revenue assuming a transaction price of $480,000, exactly as if it had included an estimate of variable consideration in the transaction price all along: Deferred revenue ($300,000 4 6 months) ................... 50,000 Bonus receivable ($180,000 4 6 months) .................... 30,000 Service revenue ($480,000 4 6 months) ................. 80,000 If TrueTech estimates that CompStores will return five percent of the Tri-Boxes purchased, TrueTech would record a liability for that amount: The sales returns account is a “contra revenue” account that has the effect of reducing revenue. As a result, we report sales revenues net of the amount expected to be returned.20 Along with the entries above, TrueTech also would need to reduce cost of goods sold and record an asset, “inventory—estimated returns,” to reflect the cost of inventory expected to be returned. In practice, most companies find it impractical to record an estimated refund liability each time they make a sale. Instead, they debit sales returns and credit cash as returns occur Sales revenue Less: Sales returns Net sales 20 Alternatively, the seller could combine the journal entries and record net revenue as: Cash .................................................................................................................................... 240,000 Sales revenue (net)........................................................................................................ 228,000 Refund liability ............................................................................................................. 12,000
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