An online seller has no stores to walk and no cash drawer to count. The evidence is data: order exports, processor settlement reports, marketplace statements and carrier tracking. Three areas produce most adjustments: the returns estimate, the gross or net decision for marketplace sales, and sales tax exposure in states where the company has no office.
Revenue recognition and the returns estimate
Revenue on a direct online sale is recognized when control passes, which is on delivery or on shipment depending on the terms and the shipping policy. Most ecommerce sellers also give customers a right to return goods, and that drives the largest estimate in the statements.
PwC's revenue guide explains that a return right does not create a separate performance obligation. It affects the transaction price, so revenue is recognized only for goods not expected to be returned. Under ASC 606-10-55-23 the seller records revenue for the goods expected to stay with the customer, a refund liability for the consideration it expects to refund, and an asset for the right to recover the goods with a matching adjustment to cost of sales. The asset starts from the former carrying amount of the goods less expected recovery costs and expected declines in value, so a returned item that cannot be resold carries no asset. The asset is presented separately from the refund liability. Both are remeasured at each reporting date.
The estimate uses the expected value or most likely amount method, constrained so that a significant reversal of cumulative revenue is not probable. See variable consideration and the constraint.
Audit steps for returns:
- Build the return rate by product category and sales month from the order system and compare it to the rate used.
- Test the return window at year end: sales in the last weeks of the year can still be returned after the balance sheet date.
- Review returns processed after year end against the reserve. This is the best evidence available.
- Test the return asset against the resalable share of returned goods, using receiving and inspection records.
Marketplace sales: principal or agent
Ecommerce companies sell in three ways: their own site, third-party marketplaces, and as an intermediary for other sellers. The treatment differs. A principal controls the specified good before it transfers to the customer and reports gross revenue. Under ASC 606-10-55-37A, control can come from obtaining a good from another party that the entity then transfers, or a right to a service performed by another party. The indicators in ASC 606-10-55-39 are primary responsibility, inventory risk, and pricing discretion, and they support the control assessment rather than replace it.
A company that buys inventory, holds it, sets the price and ships it, even through a marketplace storefront, meets the control indicators of a principal for that sale. The marketplace fee is then a selling cost. A company that hosts other sellers' listings, never holds the goods and earns a commission is an agent and reports the commission. The audit needs a conclusion for each channel and a trace of the conclusion to the contract and the operating facts. The gross vs net guide covers the framework.
Cash, processors and marketplace statements
The processor or marketplace holds cash between the sale and the payout. The audit work is a reconciliation of gross sales per the order system to settlement reports, net of fees, refunds, chargebacks and reserves held back. The three questions to answer are: which funds were earned but not yet paid out at year end, which fees were netted from deposits and not recorded as expense, and which refunds were issued by the processor and not recorded in the books. Test the receivable from the processor or marketplace with a settlement report for the last days of the year and the deposit that follows, in place of a bank confirmation.
Sales tax exposure
Before 2018 a seller needed physical presence in a state before it had to collect that state's sales tax. In South Dakota v. Wayfair, the Supreme Court held that the physical presence rule from Quill and National Bellas Hess was unsound and incorrect, and overruled both. The Court noted that South Dakota's law applied only to sellers delivering more than $100,000 of goods or services into the state or completing 200 or more separate transactions there, and that it did not apply retroactively. States now set their own economic nexus thresholds, so an online seller with customers across the country owes tax in any state where its sales pass that state's threshold, even with no office, warehouse or employee there.
The audit cannot conclude on the sales tax liability without a nexus study. Obtain sales by ship-to state, the registrations held, and the thresholds each state applies, and compare. Unregistered states with sales above the state threshold create an accrual under ASC 450 when the loss is probable and estimable, and a disclosure otherwise. Marketplace sales need separate treatment where the marketplace collects and remits the tax on the seller's behalf, and the seller's records need the marketplace's tax reports to prove it. See the glossary entry on sales tax nexus.
Worked example
An illustrative example for returns: in the fourth quarter an online seller sells 2,000 units at $60 each, which cost $24 each, a total of $120,000 of sales. It expects 8 percent to be returned, which is 160 units. Revenue is 1,840 × $60 = $110,400. Cost of sales is 1,840 × $24 = $44,160. The refund liability is 160 × $60 = $9,600, and the return asset is 160 × $24 = $3,840 if all returned units are resalable. If the seller expects a quarter of returned units to be unsellable, the asset is 120 × $24 = $2,880. If the seller records the full $120,000 as revenue and recognizes returns only when processed, revenue and gross profit are overstated by $9,600 less $3,840 = $5,760 of gross profit at year end.
On a payout reconciliation, suppose order system sales for December are $412,000, refunds $18,500, processor fees $11,900 and the payouts received in December total $370,100. Net expected is 412,000 − 18,500 − 11,900 = $381,600. The $11,500 gap is funds held by the processor or in transit, which must be a receivable and agreed to the January payout.
PBC list
- Order, shipment and return exports by month and category
- Return rate analysis and return reserve calculation
- Processor and marketplace settlement reports and bank statements
- Marketplace seller agreements and fee statements
- Sales by ship-to state, state registrations and any nexus study
- Inventory by location, including third-party warehouses and fulfillment centers
- Chargeback and dispute log
Red flags
- Return rate in the model well below the rate implied by post year end returns
- Revenue spikes in the last week of the year with high returns in the following month
- Marketplace revenue presented gross with no control analysis
- Sales into many states with registrations in one or two
- Unreconciled processor balances carried across periods
Sources
- PwC Viewpoint, Revenue from Contracts with Customers, Rights of Return: https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/revenue_from_contrac/revenue_from_contrac_US/chapter_8_practical__US/82rights_of_return_US.html
- FASB ASC 606-10-55-36 through 55-40, as amended by ASU 2016-08, text reproduced by PwC Viewpoint: https://viewpoint.pwc.com/dt/us/en/fasb_financial_accou/asus_fulltext/2016/asu_201608revenue_fr/asu_201608revenue_fr_US/asu_201608revenue_fr_US.html
- South Dakota v. Wayfair, Inc., (2018), Legal Information Institute: https://www.law.cornell.edu/supremecourt/text/17-494
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