Customer options, returns, warranties, breakage and bill-and-hold

• Determine whether a customer option is a material right and estimate its SSP
• Account for a sale with a right of return using a refund liability and recovery asset
• Distinguish an assurance-type warranty from a service-type warranty
• Apply the breakage and bill-and-hold guidance

Customer options and material rights

Customer options to buy more goods or services for free or at a discount come as sales incentives, loyalty points, renewal options and discount vouchers. Under 606-10-55-42, an option is a performance obligation only if it gives the customer a material right it would not receive without entering into the contract, such as a discount incremental to the range normally given to that class of customer in that market. An option to buy at standalone selling price is not a material right; it is a marketing offer.

When the option is a material right, part of the transaction price is allocated to it and recognized when the option is exercised or expires. If its SSP is not observable, estimate it from the discount the customer would get on exercise, adjusted for any discount available without exercising the option and the likelihood of exercise (606-10-55-44).

Loyalty programs are the common case. Points earned on a purchase defer part of the sale price until redemption.

Rights of return

Under 606-10-55-22 through 55-29, for products sold with a right of return the entity recognizes:

• revenue for products not expected to be returned, at the amount it expects to be entitled to, using the variable consideration guidance and constraint;
• a refund liability for consideration expected to be refunded; and
• an asset for the right to recover products, measured at the former carrying amount less expected recovery costs, including any decrease in the value of returned items, with a matching adjustment to cost of sales.

The promise to accept returns is not a separate performance obligation. Refund liabilities and recovery assets are remeasured each period, and the asset is presented separately from the liability (not netted). Exchanges for products of the same type, quality, condition and price are not treated as returns.

Warranties

606-10-55-30 to 55-35 distinguish two kinds:

• Assurance-type warranties provide assurance that the product complies with agreed specifications. They are not performance obligations; the entity accrues the expected cost under the loss contingency guidance.
• Service-type warranties provide a service beyond that assurance. They are performance obligations that receive an allocation of transaction price.

If the customer can buy the warranty separately, it is a distinct service (606-10-55-31). If not, consider whether the warranty is required by law (suggesting assurance), the length of coverage (longer suggests service) and the nature of the tasks the entity promises.

Breakage

Customers often prepay for rights they never use, such as gift cards. Under 606-10-55-48, if the entity expects to be entitled to breakage, it recognizes the expected breakage as revenue in proportion to the pattern of rights the customer exercises. If it does not expect to be entitled to breakage, it recognizes breakage when the likelihood of the customer exercising its remaining rights becomes remote. Estimates are constrained like other variable consideration. Unclaimed property laws that require remitting unused balances to a state take precedence: amounts owed to a state are a liability, not breakage revenue.

Bill-and-hold

A customer may pay for a product the entity keeps at its site. Under 606-10-55-83, beyond the general control indicators, all of these must be met for control to have transferred:

• the reason for the arrangement is substantive (for example, the customer requested it);
• the product is identified separately as belonging to the customer;
• the product is ready for physical transfer; and
• the entity cannot use the product or direct it to another customer.

If control transfers, the entity considers whether custody is a separate service that receives part of the price.

Consignment and repurchase

A product on consignment at a dealer is still controlled by the entity until the dealer sells it or a specified period ends. Repurchase agreements (forwards, calls and puts) often mean the customer never obtains control, and the arrangement is a lease or a financing.

See the refund liability calculator and the breakage calculator.

Returns at year-end for a consumer products company