Revenue transactions

Warranties

As a recap, there are two types of warranties:

1. Service type warranty
2. Assurance type warranty

Service type warranties

These are warranties that are considered separate performance obligations in the revenue recognition assessment under ASC 606. These warranties can either be purchased as a separate product or they provide an additional service to the customer in order to comply with the warranty agreement such as providing extended repairs and replacement services.

This indicates that the company will provide additional services beyond the normal assurance that the product functions as intended.

Part of the transaction price is allocated to the warranty and recorded as a contract liability (unearned warranty revenue), which is recognized as revenue over the warranty coverage period. For example, if $50 of a $1,000 sale price relates to a three-year extended warranty, the company recognizes about $16.67 of that $50 as revenue each year of the coverage period.

Assurance type warranties

These are warranties that are not separate performance obligations.

These warranties do not provide additional service to the customer but only provide assurance that a product will comply with certain agreed specifications. These types of warranties are not available to be purchased separately, such as providing a warranty for manufacturing defects up to one year after the sale. These fall under ASC 460 (Guarantees), and their expected cost is accrued as a loss contingency (ASC 450).

Estimated warranty costs are accrued at the time of sale as warranty expense with a warranty liability. For example, if a company expects 2% of its $100,000 in sales to require warranty repairs, it records $2,000 of warranty expense and a $2,000 warranty liability at the time of sale.

Consignment sales

Consignment sales have been partially discussed in the section about inventories with the particular focus on the inventory side of the transaction.

Consignor’s books

Since the consignor is the owner of the goods until the time they are sold by the consignee, the main accounting by the consignor upon delivery of the goods to the consignee is just to transfer the cost of the goods from the main inventory account to an inventories out on consignment account and capitalize all freight costs paid when delivering the goods to the consignee’s warehouse.

For example, assume Achievable Co. (the consignor) ships goods costing $600 to a consignee, paying $50 of freight to deliver them, and the consignee later sells the goods for $1,000 while earning a 10% commission.

The credit in cash in the journal entry above represents the costs to deliver inventories to the consignee. These are capitalizable costs and should not be expensed.

When the inventory is finally sold by the consignee, the consignor should record the full revenue from the sale. Any commissions paid to the consignee are recorded separately in an expense account and should not be netted from the revenues.

Assuming the perpetual inventory system is used, the consignor should record the cost of goods sold.

Consignee’s books

The consignee is just an agent of the consignor on the sale. Consignees do not record any journal entry when the goods have been received in their warehouse since they do not have ownership of the consigned goods. The revenues of the consignee are in the form of the commission revenues.

The liability is then debited and cash is credited for $900 upon remittance to the consignor.

Contracts with right to return

Some sales arrangements allow for customers to hold the goods but they are given a period in which to decide whether they will purchase or return the goods.

In such contracts the right to return the product is not treated as a separate performance obligation, however revenue is recorded only net of the expected returns. ASC 606 has provided guidance on how to account for such contracts. According to the Codification, the following should be recognized upon sale:

• Revenue for the transferred products net of the expected returns
• Refund liability based on the expected amounts to be refunded to the customers
• A refund asset representing the company’s right to recover products from the customer in settling the refund liability. This is recorded as an adjustment to the cost of goods sold originally recorded upon sale

Example: Sale with right of return

Assuming Achievable Co. sells 100 units of Product A to a customer with a right to return products for any reason for a full refund within 120 days. Product A costs $20 and is sold for $50 per unit. Based on Achievable’s Co.'s estimate 5% of the sales will be returned for a full refund. Achievable Co. has no further obligations to the customer after transferring control of product A.

Answer: Expected returns = 5% × 100 = 5 units. Refund liability = 5 × $50 = $250, so revenue = $5,000 − $250 = $4,750. Refund asset = 5 × $20 = $100, so cost of goods sold = $2,000 − $100 = $1,900. The following are the journal entries under ASC 606.

Account	Debit	Credit	Financial statement element
Cash	5,000		Asset
Sales revenue		4,750	Revenue
Refund liability		250	Liability
To record the sales revenue net of estimated returns

Account	Debit	Credit	Financial statement element
Cost of goods sold	1,900		Expense
Refund asset	100		Asset
Inventory		2,000	Asset
To record the cost of goods sold net of the refund asset

At the end of the period, the refund asset should be assessed for impairment and the refund liability should be assessed for any expired agreements and revision of estimates.