Returns and markdown allowances

What are returns and markdown allowances?

Retailers buy on terms that limit their risk of being left with stock they cannot sell. Under a right of return, the retailer can send back goods that are unsold at the end of a season, damaged in its supply chain or close to their use-by date, in exchange for a refund, a credit or a different product. Under a markdown allowance, the retailer keeps the goods and cuts the shelf price, and the supplier pays for part of the price cut. Price protection is a related term: if the supplier lowers its list price, it credits the retailer for the difference on stock the retailer already holds. Some of these rights are written into contracts; others come from the supplier's customary practice, which IFRS 15 treats in the same way because it gives the retailer a valid expectation. See FMCG accounting.

How does IFRS 15 treat a right of return?

A right of return is not a separate performance obligation. Instead, the amount the supplier may have to refund is variable consideration. When it transfers the goods, the supplier recognises:

• revenue for the goods it expects to keep sold, estimated using the expected value or the most likely amount and constrained so that a significant reversal is highly unlikely;
• a refund liability for the amount it expects to refund or credit; and
• an asset for its right to recover goods from the retailer, measured at the goods' former carrying amount less the expected costs of recovering them, including any fall in their value, with a matching reduction in cost of sales.

Exchanges of one product for another of the same type, quality, condition and price, such as one flavour for another, are not returns. Exchanges of faulty goods for working ones are dealt with as warranties. See variable consideration.

Returns and markdown allowances: a seasonal range

A confectionery supplier sells 50,000 units of a Christmas gift range to a retailer at US$ 4 each, 200 thousand in total. The goods cost 2.40 a unit to make, 120 thousand. The retailer can return unsold stock in January, and past seasons suggest 6% of the units, 3,000, will come back. Returned units can only be sold to discount stores, for about 1.50 each after collection costs. The supplier also has a practice of funding markdowns in the last week before Christmas, and expects to pay 0.40 a unit on 10,000 units, 4 thousand.

The supplier recognises revenue of 184 thousand, not 200, and a refund liability of 16 thousand for expected returns and markdown support. Its cost of sales is 115.5 thousand rather than 120, because the 3,000 units it expects back are worth 4.5 thousand to it, not their original cost of 7.2 thousand: the 2.7 thousand loss in value belongs in this season's cost of sales. The refund liability and the returned goods asset are presented separately, not netted.

What happens when actual returns differ?

At each reporting date, the supplier updates its estimates of returns and markdown support. Changes in the refund liability adjust revenue, and matching changes in the asset adjust cost of sales. If 3,400 units come back, 400 more than expected, the supplier reduces revenue by a further 1.6 thousand and increases the returned goods asset by 0.6 thousand. When goods come back, they go into inventory at the asset's carrying amount and are then measured at the lower of cost and net realisable value. See short-dated and expiring stock.

How are markdown support and price protection estimated?

Markdown support is usually agreed after the sale, when the retailer sees which lines are not selling, so the supplier estimates it from its history of support by season, category and retailer, the retailer's current sell-through data and the stock the retailer still holds. Price protection depends on the supplier's own pricing plans: if it expects to cut list prices before the retailer sells its stock, the expected credit reduces revenue when the original goods are sold. Both are consideration payable to a customer, so they reduce revenue rather than being marketing expense. See trade promotion spending.

How are allowances for damaged goods treated?

Many suppliers avoid handling damaged or out-of-date goods from retailers by giving a fixed allowance for unsaleable goods instead, for example 1% of invoiced sales, and the retailer disposes of the goods itself. Because the supplier gives up that part of the price whatever happens, the allowance is a price reduction that reduces revenue when the goods are sold, and the supplier recognises no asset for goods it will never get back. Where the supplier instead replaces goods that were faulty when delivered, it accounts for the cost as an assurance-type warranty, with a provision under IAS 37. See product warranties.

What about guaranteed sales and new launches?

Some products, such as magazines and some new launches, are sold on terms that let the retailer return everything it does not sell. Where the supplier has little history to estimate returns, the constraint may limit revenue to a small amount until the retailer sells the goods. Where the retailer has no obligation to pay until it sells the goods, the arrangement may be a consignment, with no revenue until the goods are sold to shoppers. See consignment and bill-and-hold.

How does the retailer account for these allowances?

For the retailer, markdown support and price protection received from suppliers reduce the cost of the goods it bought, and reach profit or loss through cost of sales as those goods are sold, rather than being income. Goods sent back to suppliers are removed from inventory, with a receivable for the refund. A retailer's own refunds to shoppers are a separate question. See supplier rebates and allowances and returns and refunds in retail.

How does US GAAP differ?

ASC 606 uses the same model: revenue net of expected returns, a refund liability, and an asset for the right to recover products, presented separately. Markdown allowances and price protection are variable consideration, estimated and constrained in the same way. On the retailer's side, ASC 705 generally treats such payments as reductions of the cost of purchases. See volume rebates to retailers.

This guide is general information. It is not tax or legal advice for your situation.