CPA Exam - FAR (Financial Accounting and Reporting)Select TransactionsEasy
A company sells a product for $1,000 with a right of return. Based on historical data, the company estimates that 10% of customers will return the product. The cost of the product is $600. How much revenue should the company recognize at the time of sale?
- A$0
- B$1,000
- C$400
- D$900
Show answer & explanationAnswer & explanation
Correct answer: D. $900
Under ASC 606, revenue is recognized for the amount of consideration the entity expects to be entitled to receive. If a right of return exists, the company must estimate the returns and only recognize revenue for the amount expected to be retained.
Why the other options are wrong
- A. This implies no revenue can be recognized, which is incorrect if returns are estimable.
- B. This recognizes 100% of the sale, ignoring the estimated returns.
- C. This represents the estimated gross profit, not the revenue recognized.
Revenue Recognition with Right of Return
When a customer has a right of return, an entity recognizes revenue for the amount of consideration it expects to be entitled to, net of estimated returns.
- Estimate returns based on historical data or other evidence.
- Recognize a refund liability for the estimated returns.
- Recognize an asset for the right to recover goods from customers.
Memory trick: FIVE steps to RECOGNIZE the REVENUE, especially when returns are in play!