For some time now, companies have been grappling with a peculiar issue related to the recognition of sales returns after the reporting date. While the issue is relevant to all industries, it is more so for the consumer goods sector such as garments, footwear, white goods, accessories and so on, where sales happen through various dealers, distributors and franchise channels with the understanding that unsold goods can be returned to the seller. Companies have chosen the guidance available under Accounting Standard 9: Revenue Recognition and AS-29 — Provisions, Contingent Liabilities and Contingent Assets, often leading to varied practices.

Some argue that the sales recognised before the reporting date, but which have been returned subsequently (prior to finalisation of accounts), should be reversed on the reporting date itself. However, the inherent limitation here is that when the finalisation happens close to the reporting date, there could be sales that were recognised before the reporting date but the potential returns could come after the finalisation. Secondly, for such sale reversal, it must be confirmed whether the revenue recognition criteria stipulated under AS-9 were fulfilled when recording the sale. Under AS-9 the revenue can be recognised if the seller transfers all the significant risks and rewards of ownership to the buyer, and no significant uncertainty exists over the consideration derived from the sale. Accordingly, if both conditions exist at the time of revenue recognition, the company should not record sale reversal for returns after the reporting date, as the revenue was correctly recorded on initial recognition.

Another accounting view suggests that one should estimate the sales return likely after the reporting date, and reverse them on the reporting date itself. While this alternative mitigates the inherent limitation stated in the first alternative, one still has to confirm whether the revenue recognition criteria under AS-9 were fulfilled at initial recognition.

Thus, there is uncertainty in a situation where the revenue recognition criteria were met when recording the sales, but there were returns, or returns are expected after the reporting date but before the finalisation of accounts. An illustration under AS-29 can be relied on, as also an opinion issued by the Expert Advisory Committee of the Institute of Chartered Accountants of India in October 2011, suggesting that the seller should recognise a provision for sales returns as a best estimate of the expected loss (which would typically be the gross margins earned by the seller on initial revenue recognition), including any estimated cost that may be incurred to resell the goods on the basis of past experience and other factors.

There should be adjustments for actual sales returns after the reporting date, up to the finalisation of accounts, and the provision should be reviewed at each reporting date to reflect the current best estimate. Similar guidance is available under International Accounting Standard 37: Provisions, Contingent Liabilities and Contingent Assets, as also under Accounting Standard Code 605-30: Revenue Recognition, and ASC 450-20-25: Contingencies, as stipulated in the accounting principles generally accepted in the US (USGAAP).

Besides applying recognition and measurement principles to the provision for sales returns, the seller should comply with the disclosure requirements stipulated under AS-1: Disclosure of Accounting Policies and AS-29.

Chartered accountant Sumit Mahajan contributed to the article.

The author is Partner, Assurance, Grant Thornton India LLP.

(This article was published on January 5, 2014)
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