How to test a sale with a right of return under Ind AS 115

Testing a sale with a right of return means testing that the entity recognised revenue only for the consideration it expects to be entitled to keep — total consideration less the amount expected to be refunded — recognised a refund liability for the amount expected to be returned, and recognised a separate asset, with a corresponding adjustment to cost of sales, for its right to recover the goods expected to come back. All three components move together and should be tested together, not as a single net revenue adjustment.

Why three balances, not one

It is common to see an entity reduce revenue by an estimated returns percentage and stop there, treating the adjustment as a single net figure. Ind AS 115 requires the refund obligation to be recognised gross as a liability, and the returned goods the entity expects to recover to be recognised as a separate asset measured at the former carrying amount of the inventory, less any expected costs to recover it and any expected reduction in value. Testing only the net revenue figure misses whether the liability and the asset are each individually right.

The testing sequence

1. 01Identify the population of sales with a contractual or customary right of returnA contractual return right is explicit in the sale terms; a customary right arises from the entity's established business practice of accepting returns even without a contractual obligation to do so, and both are in scope.
2. 02Obtain the entity's estimate of the expected return rate and its basisThe estimate should be built from the entity's own return history, segmented by product line or channel where return behaviour genuinely differs, rather than a single blended rate applied across dissimilar products.
3. 03Test the historical return rate against actual returns processed after the reporting dateCompare the prior year's estimated return rate to what was actually returned in the following months — a persistent gap between estimate and outcome, in one direction, signals the estimation approach itself needs revisiting, not just this year's number.
4. 04Recompute the revenue recognised net of the estimated refund obligationGross sales for the period, less the refund liability computed at the estimated return rate applied to the gross transaction price, equals the revenue that should be recognised.
5. 05Recompute the refund liability balance separatelyThis should be carried as a liability, not netted against trade receivables or against revenue in the balance sheet, and recomputed at each reporting date as the estimate is updated.
6. 06Recompute the asset for the right to recover returned goodsMeasured at the former carrying amount of the inventory expected to be returned, adjusted for the expected cost of recovering it and any expected decline in the value of the returned goods, and tested the same way inventory is tested for net realisable value.
7. 07Test actual returns received during the year against the opening refund liabilityA return processed in the period should reduce the refund liability and the right-of-recovery asset that were set up for it, not be run through revenue or cost of sales again as if it were a fresh transaction.