FAR · Select transactions · 6 practice questions
ASC 606 Right of Return: Revenue and Refund Liability
Revenue excludes total expected refunds, while the ending refund liability covers only refunds still unpaid. Below: a worked example separates these amounts and calculates the recovery asset and cost of goods sold.
Try one first
Hint
Compute expected total returns first, then separate the part already refunded from the part that remains as a year-end liability.
Answer C. Total sales equal 500 × $200 = $100,000. Expected returns are 8% of 500 units = 40 units, or $8,000, so revenue is recognized net of expected returns: $100,000 − $8,000 = $92,000. Ten units ($2,000) have already been returned and refunded, so the refund liability at year-end covers the remaining expected returns: 30 units × $200 = $6,000.
Why not A: This reflects reducing revenue only for actual returns to date (10 units) while separately booking a liability for remaining expected returns. Under ASC 606, revenue should reflect the amount the entity expects to be entitled to, so it is reduced for total expected returns (40 units), not only actual returns.
Why not B: This correctly reduces revenue for total expected returns but overstates the year-end refund liability by including refunds already processed; the liability should reflect only expected future refunds not yet paid (40 expected − 10 already refunded = 30 units, $6,000).
Why not D: This treats the sale as full revenue with a separate liability for all expected returns. When returns can be reasonably estimated, the revenue-recognition model requires recognizing revenue net of expected returns rather than leaving gross revenue of $100,000.
Worked example
Pine Co. sells 300 units for $100 each, collects cash, and transfers control. Each unit costs $60. Customers have a 60-day full-refund return right. At year-end, the window remains open. Pine reliably estimates total returns of 10%; 10 units have already been returned and refunded. Returned goods are resalable at original cost, with no recovery costs.
| 1 | Original sales amount300 × $100 | $30,000 |
| 2 | Total expected returns300 × 10% | 30 units |
| 3 | Cumulative revenue$30,000 − (30 × $100) | $27,000 |
| 4 | Returns still expected30 − 10 | 20 units |
| 5 | Ending refund liability20 × $100 | $2,000 |
| 6 | Ending recovery asset20 × $60 | $1,200 |
| 7 | Cumulative COGS(300 − 30) × $60 | $16,200 |
Pine reports $27,000 of cumulative revenue, a $2,000 refund liability, a $1,200 recovery asset, and $16,200 of cumulative COGS.
Check: Revenue and COGS use 270 units expected to remain sold; the refund liability and recovery asset use 20 returns still outstanding.
Key points
- Use the latest total-return estimate at each reporting date; record the change in revenue in that period.
- Refunds already paid settle the liability; they do not reduce cumulative revenue again if the total-return estimate is unchanged.
- Measure the recovery asset at inventory cost, not selling price, reduced for recovery costs and decreases in value.
- Revenue need not wait until the return window closes if control has transferred and the variable consideration constraint is met.
How the exam traps you
- Reducing revenue only for actual returns processed. Reduce cumulative revenue for total expected returns, including those not yet received.
- Leaving refunds already paid in the ending refund liability. Subtract refunds already paid from total expected refunds.
- Leaving COGS at the full cost of all units sold. Recognize the recovery asset and reduce COGS for expected returns.
Question 2
Hint
Focus on how a right of return affects the transaction price when expected returns can be estimated reliably.
Answer A. Revenue is recognized for the amount the entity expects to be entitled to after considering expected returns. Expected refunds are 4% of $120,000, or $4,800, so recognized revenue is $115,200. The expected refund is recorded separately as a refund liability rather than included in revenue.
Why not B: This is tempting because control transferred in Year 1, which is the basic trigger for recognizing revenue. However, when a right of return exists and expected returns can be estimated reliably, revenue is recognized net of expected refunds, not at the full sales price.
Why not C: This amount is tempting because it is the computed effect of the return estimate. But $4,800 is the expected refund liability, not the revenue amount; revenue is the sales price less that expected refund.
Why not D: A candidate might think revenue must wait until the 30-day return window expires. That is incorrect when the seller can reasonably estimate returns and the estimate is not expected to cause a significant reversal; in that case, revenue is recognized immediately, net of expected returns.
Question 3
Hint
Under a right of return, analyze the sales side and the inventory side separately.
Answer C. A right of return creates variable consideration. Orchard should recognize revenue only for the portion not expected to be returned: $100,000 × 94% = $94,000, and recognize a refund liability for expected returns. For inventory, Orchard recognizes an asset for the right to recover expected returns measured at carrying amount (30 units × $120 = $3,600); therefore COGS equals the cost of units expected to remain (total cost $60,000 − $3,600 = $56,400).
Why not A: This choice applies the inventory-side adjustment (reducing COGS for expected returns) but incorrectly recognizes full revenue rather than limiting revenue to the amount not expected to be returned.
Why not B: This option correctly reduces revenue for expected returns but fails to recognize the right-to-recover inventory asset, so it incorrectly leaves COGS at the full cost of all units.
Why not D: This option ignores the expected returns entirely and treats the sale as final for both revenue and COGS, which is inconsistent with ASC 606 when returns are expected and estimable.
Question 4
Hint
First determine the consideration Rell expects to retain (transaction price less total expected refunds); then decide what remains payable as refunds after accounting for returns already processed.
Answer D. Under ASC 606, when returns can be estimated reliably, revenue is the consideration the seller expects to retain (transaction price less total expected refunds). Total expected refunds = 80 × $200 = $16,000, so revenue = $200,000 − $16,000 = $184,000. The refund liability at 12/31 reflects expected future refunds after accounting for returns already processed: remaining expected returns = 80 − 30 = 50 units, so refund liability = 50 × $200 = $10,000.
Why not A: This ignores the ability to estimate returns and recognizes full sales revenue with no refund obligation. It fails because ASC 606 requires an adjustment for estimated returns when they can be reasonably estimated.
Why not B: This is tempting for candidates who reduce revenue only for the 30 returns already processed (1,000 − 30 = 970 × $200 = $194,000) and treat the liability as the refunds already paid (30 × $200 = $6,000). It is incorrect because ASC 606 requires reducing revenue for total expected returns, and the refund liability at year‑end should reflect expected future refunds (50 × $200 = $10,000), not refunds already paid.
Why not C: This reflects subtracting only the 50 units expected to be returned after year‑end (1000 − 50 = 950 × $200 = $190,000) while listing the full expected refunds as the liability. It is wrong because revenue must be reduced by total expected returns (80 units), and the refund liability at the reporting date should reflect remaining expected refunds after returns already processed.
Question 5
Hint
Separate the question into two measurements: total expected returns for cumulative revenue, and only unresolved expected refunds for the ending liability.
Answer C. Under ASC 606, revenue is measured net of the consideration the entity expects to refund for returns. Milo expects total returns of 28 units, so cumulative revenue = $400,000 − $28,000 = $372,000. The refund liability at December 31 is for refunds still expected after the 8 units already returned, i.e., 20 units × $1,000 = $20,000.
Why not A: This option nets revenue only for the 8 units actually returned to date (400k − 8k), instead of reducing cumulative revenue for the total expected returns (28 units). Revenue should reflect the most current estimate of total returns.
Why not B: This choice reflects the original 5% (20-unit) estimate and does not apply Milo's updated expectation of 28 total returns, so it understates expected refunds and overstates revenue.
Why not D: Although the cumulative revenue here correctly reflects total expected returns, the ending refund liability is overstated: it should include only future refunds still expected (28 total expected − 8 already refunded = 20 units × $1,000 = $20,000).
Question 6
Hint
For a sale with a right of return, think about two entries tied to expected refunds: one affects revenue, and one affects liabilities.
Answer B. Total consideration is 1,000 × $500 = $500,000. Expected returns are 4% of $500,000 = $20,000. Under ASC 606, Merin recognizes revenue for the amount it expects to be entitled to keep ($500,000 − $20,000 = $480,000) and records a refund liability of $20,000 for expected refunds.
Why not A: This ignores ASC 606's requirement to estimate returns when reliable; waiting until returns occur understates the liability and overstates revenue at the sale date.
Why not C: Recording the full $500,000 of revenue while also recognizing a refund liability double-counts revenue. The amount expected to be refunded should not be recognized as revenue.
Why not D: Netting revenue for expected returns is correct, but ASC 606 also requires a separate refund liability for the amount expected to be returned; omitting the liability understates obligations.
Common questions
How do you calculate ASC 606 revenue for sales with a right of return?
Subtract total expected refunds from the original sales amount. Use the latest estimate of total returns, not just actual returns or returns still outstanding.
Why is the ending refund liability less than total expected refunds?
Refunds already paid are no longer obligations. The ending refund liability equals total expected refunds minus refunds already paid.
How do sales returns affect the recovery asset and COGS?
The ending recovery asset covers products still expected back, measured at inventory cost less recovery costs and decreases in value. With no such reductions, cumulative COGS equals the cost of units expected to remain sold.
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