Before we discuss the recognition principle and accounting treatment for sales under sale or return conditions. First lets have ourselves clear about what is meant by sale or return?
Under sale or return, the goods are sent by the supplier to the customer with an understanding that customer does not have to pay for such goods until these goods are used or sold by the customer and if such goods are not sold or used then customer will return such goods back to supplier. Now what constitutes the sale or use may depends upon the contract between the supplier and customer and things may get very technical. For example, customer was able to sell part of the shipment sent by the supplier and now wants to send the rest back to supplier but supplier insists that sale of whole package has occurred and the rest of the goods now belong to the buyer. This and many other situations make sale of goods very interesting complex things to solve. For the same reason we have Sales of Goods Act.
Coming back to the question.
In order to understand whether we can recognize revenue in respect of such goods which have been sent under sale or return option, we have to understand the basic recognition principle or criteria given by International Accounting Standard IAS 18 Revenue.
According to IAS 18 para 14, revenue on sale of goods shall be recognized (only) when the following set of conditions is fulfilled:
- the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;
- the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;
- the amount of revenue can be measured reliably;
- it is probable that the economic benefits associated with the transaction will flow to the entity; and
- the costs incurred or to be incurred in respect of the transaction can be measured reliably.
The condition relevant to our current discussion is that revenue shall be recognized when:
the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;
The underlying principle that constitutes sale is whether risk and rewards associated with the goods have been transferred or not.
- If the risks and rewards have been transferred then this constitutes a sale. The conclusion whether the transfer is done depends on many factor including the contract between the parties or the circumstances of the situation i.e. actions of parties.
- If the risks and rewards have not been transferred then sale will not occur for the respective goods either for whole goods or part of the goods depending on the situation.
Here are some of the examples under which supplier might retain risks and rewards of ownership of the goods:
- Supplier agreed to take additional responsibility which are not covered under normal terms of warranty;
- Supplier’s revenue is promised only if buyer obtains revenue by selling its goods (sale or return).
- Sale of goods is contingent on completion of installation which is not yet complete and
- Buyer is given the option to cancel sales and buyer still holds such option thus making sales uncertain.
Uncertainties associated with sales usually dissolves with the receipt of consideration of such goods. However, this is not always the case. Sometimes even after the receipt of payment sale remains uncertain and sometimes even without receiving any money uncertainties are lifted because of buyer’s actions.
Until the recognition criteria given is not fulfilled, sale does not occur even if the goods are possessed by the buyer. Possession is not the ultimate factor to conclude sales.
Under sale or return situation, if the risks and rewards have not been transferred, goods will be added in the closing stock of supplier in supplier’s accounting books. Even if such goods are held by the buyer, these goods do not belong to the buyer and he cannot include such goods in his stock for stock valuation purposes as title of ownership is still with the supplier.