14.3 Refund Liabilities
Some contracts with customers may result in refund liabilities owed
to customers. The most common of such refund liabilities are return provisions in
sales contracts that permit the customer to return the product if certain
circumstances arise. These liabilities may also arise when an entity receives cash
in advance, but the agreement is cancelable because of certain termination
provisions in the agreement (see Section 4.4.1). When these provisions are present in a contract, the
seller would recognize a liability to reflect its obligation to return amounts paid
or payable by the customer (i.e., a refund liability).
An agreement that includes a provision for termination without penalty may not be a
contract under step 1 of ASC 606 (i.e., a contract may not exist for the cancelable
term). Such a provision may therefore affect the presentation of these arrangements
on the balance sheet. For a cancelable contract (with a termination right without
penalty), funds received in advance should not be classified as a contract
liability. Funds received in advance that are associated with a cancelable term
(with a termination right without penalty) should be presented separately from any
contract liability as a refund liability, or similar liability.
A refund liability should not be presented together with contract
liabilities that arise under the same contract. A contract liability is defined in
ASC 606-10-45-2 as “an entity’s obligation to transfer goods or services to a
customer for which the entity has received consideration (or an amount of
consideration is due) from the customer.” A refund liability, however, represents
the customer’s conditional right to consideration from the seller (as opposed to
consideration receivable from the customer) and does not represent a performance
obligation. Consequently, we believe that the refund liability should be presented
separately from the contract liability. Note that as a result, the refund liability
would not be netted with any contract assets the entity may recognize.
Example 14-1
Entity A sells Product X to 10 separate
customers for $100 each and does not charge a restocking
fee. On the basis of its historic experience, A expects that
one of these products will be returned. As a result, A
should recognize a refund liability of $100 for the one
product out of 10 that it expects will be returned. In
addition to Product X, A also sells Product Z (considered a
separate performance obligation from Product X). One
customer has prepaid for Product Z in the amount of $1,000.
As a result, A has recorded a contract liability of
$1,000.
In accordance with the guidance above, A
should record a refund liability of $100 and a separate
contract liability of $1,000 (i.e., A should not present the
refund liability together with the contract liability).
For a discussion about offsetting refund liabilities against
accounts receivable, see Example
14-6.