1. What does IFRS 15 require when a product is sold with a right of return?
Recognise revenue only for the products you expect to keep sold, put up a refund liability for the rest, recognise a return asset for the right to get the goods back, and adjust cost of sales to match (IFRS 15.B21). Four legs. The promise to stand ready to accept returns is not itself a performance obligation (IFRS 15.B22).
The standard first describes the arrangement it is talking about: "In some contracts, an entity transfers control of a product to a customer and also grants the customer the right to return the product for various reasons (such as dissatisfaction with the product) and receive any combination of the following: (a) a full or partial refund of any consideration paid; (b) a credit that can be applied against amounts owed, or that will be owed, to the entity; and (c) another product in exchange."
Three things follow from the wording. First, control has already transferred. A right of return does not delay the transfer of control, so it does not delay the point at which the sale is recognised. Second, the form of the redress does not matter. A store credit is treated the same as a cash refund. Third, the guidance also reaches "some services that are provided subject to a refund" (IFRS 15.B21), so a money-back service guarantee is within scope even though there is no physical product to recover.
This is the operative paragraph and it is worth reading word for word. "To account for the transfer of products with a right of return (and for some services that are provided subject to a refund), an entity shall recognise all of the following: (a) revenue for the transferred products in the amount of consideration to which the entity expects to be entitled (therefore, revenue would not be recognised for the products expected to be returned); (b) a refund liability; and (c) an asset (and corresponding adjustment to cost of sales) for its right to recover products from customers on settling the refund liability."
Note the phrase "all of the following". It is not a menu. Sub-paragraph (c) contains two items in one clause: the asset, and the corresponding adjustment to cost of sales. Counting them out, the entry has four moving parts. Revenue is reduced. A refund liability is recognised. A return asset is recognised. Cost of sales is reduced by the amount of that asset. An entry that stops after the first two is not a partial application of IFRS 15.B21; it is a misstatement of both gross assets and gross margin.
"An entity's promise to stand ready to accept a returned product during the return period shall not be accounted for as a performance obligation in addition to the obligation to provide a refund."
This closes off a line of argument that surfaces regularly in review. Someone notices that the entity is standing ready for thirty days and reasons, by analogy to a stand-ready service, that part of the price should be allocated to that promise as a separate performance obligation. IFRS 15.B22 says no. The return right is variable consideration, not a promised good or service. It runs through step 3 of the model, not step 2. That is why the analysis lives in the same conceptual box as rebates and price concessions rather than in the performance obligation identification work.
Why the four-leg discipline matters
The two-leg version of this entry is common enough that it deserves naming. In it, the preparer credits revenue net of the expected returns and credits a refund liability, then relieves inventory in full and charges the whole cost to cost of sales. Revenue is right. Profit is wrong, because the cost of the units expected to come back has been expensed even though the entity expects to have them back on the shelf within weeks. Total assets are wrong, because the return asset is missing. Gross margin percentage is wrong in both directions across the return window, understated in the period of sale and overstated in the period when the goods physically return and are credited straight back into inventory.
The size of the error is not trivial in a business with a high return rate. Online apparel retailers commonly experience return rates well above those of physical stores, and every point of return rate multiplies straight into the return asset. The asset is a balance sheet line that auditors expect to see, and its absence tends to be the first thing that flags a mechanical shortcut in the revenue process.
Practitioner note
When you inherit a returns process, do not start with the accounting policy note. Start with the system. Ask whether the returns accrual is calculated on gross sales value or on units. If it is calculated as a percentage of sales value only, there is usually no unit population behind it, which means there is no way to compute the return asset properly, which usually means it does not exist. That single question resolves the point faster than reading the policy.
Local FAQs
Does a right of return stop revenue being recognised at all? No. Control has transferred (IFRS 15.B20). Revenue is recognised for the products the entity expects to keep sold, and the return right is dealt with through the transaction price (IFRS 15.B21(a)).
Is the refund liability a contract liability? It is a refund liability as defined in IFRS 15.55, measured at the amount of consideration received or receivable for which the entity does not expect to be entitled. IFRS 15.55 directs you to paragraphs B20 to B27 for a sale with a right of return specifically. It sits alongside, but is distinct from, the contract asset and contract liability balances that arise from the timing of performance and payment.
What if the customer receives a credit note rather than cash? IFRS 15.B20(b) expressly contemplates "a credit that can be applied against amounts owed, or that will be owed, to the entity". The accounting is the same. The settlement mechanism does not change the analysis.
Potential risks
The first risk is estimation. The amount of consideration the entity expects to be entitled to is a variable consideration estimate, and IFRS 15.B23 requires the entity to apply paragraphs 47 to 72, including the constraint in paragraphs 56 to 58. A new product line, a new market or a change in returns policy all reduce the predictive value of historical rates, which is one of the factors in IFRS 15.57(c) that increases the likelihood of a revenue reversal. See the detail in variable consideration and the constraint.
The second risk is completeness of the population. Returns received after the reporting date that relate to pre-year-end sales must be reflected in the estimate. Systems that only recognise a return when it is physically scanned back into the warehouse can leave in-transit returns out of the year-end position entirely.
The third risk is the value of what comes back. IFRS 15.B25 requires expected decreases in the value to the entity of returned products to be reflected in the asset. Seasonal goods, opened electronics and perishable stock frequently come back worth materially less than they went out.
2. How is the return asset measured, and what changes at each reporting date?
The return asset starts at the former carrying amount of the product, less expected costs to recover it and less any expected fall in its value to the entity (IFRS 15.B25). It is never selling price. At every reporting date three things get updated: the estimate of consideration the entity expects to be entitled to (IFRS 15.B23), the refund liability with the adjustment going to revenue (IFRS 15.B24), and the return asset with the adjustment going to cost of sales (IFRS 15.B25).
"An entity shall apply the requirements in paragraphs 47–72 (including the requirements for constraining estimates of variable consideration in paragraphs 56–58) to determine the amount of consideration to which the entity expects to be entitled (ie excluding the products expected to be returned). For any amounts received (or receivable) for which an entity does not expect to be entitled, the entity shall not recognise revenue when it transfers products to customers but shall recognise those amounts received (or receivable) as a refund liability. Subsequently, at the end of each reporting period, the entity shall update its assessment of amounts for which it expects to be entitled in exchange for the transferred products and make a corresponding change to the transaction price and, therefore, in the amount of revenue recognised."
Two practical points. The expected-value method under IFRS 15.53(a) is the natural choice for a large population of similar transactions, because the entity is estimating how many of a homogeneous set of units come back, not which outcome occurs on a single contract. And the constraint applies. A retailer with ten years of stable return data on a mature product range will conclude that no significant reversal is likely and will recognise revenue at the full expected amount. A manufacturer launching a product into a new territory with a generous returns policy and no history has a much weaker basis, and the constraint may require a more cautious transaction price.
"An entity shall update the measurement of the refund liability at the end of each reporting period for changes in expectations about the amount of refunds. An entity shall recognise corresponding adjustments as revenue (or reductions of revenue)."
The line to hold on to is the second sentence. A movement in the refund liability driven by a change in expected returns is a revenue adjustment. It is not an operating expense, not a credit to cost of sales, and not an exceptional item. If the entity over-provided for returns last year, the release goes through revenue this year. Analysts reading a revenue line that includes such releases are entitled to an explanation, which is why IFRS 15.119(d) requires disclosure of "obligations for returns, refunds and other similar obligations".
"An asset recognised for an entity's right to recover products from a customer on settling a refund liability shall initially be measured by reference to the former carrying amount of the product (for example, inventory) less any expected costs to recover those products (including potential decreases in the value to the entity of returned products). At the end of each reporting period, an entity shall update the measurement of the asset arising from changes in expectations about products to be returned. An entity shall present the asset separately from the refund liability."
Unpack the measurement in three components. Start with the former carrying amount, which for a retailer is the inventory cost of the units expected to come back. Deduct the expected costs to recover those products: return carriage, receipt and inspection handling, repackaging, and in some cases refurbishment. Deduct the expected decrease in value: the markdown that opened, seasonal or superseded stock will suffer before it can be sold again. The result is what the entity realistically expects to have as inventory once the goods are back on its shelves.
The last sentence prohibits netting. The return asset appears on the asset side, the refund liability on the liability side, and the two are not offset. In presentation terms the return asset is usually grouped with inventories or shown as a separate current asset caption. It is not a contract asset, because it is not a right to consideration in exchange for goods or services transferred; it is a right to recover physical goods.
The remeasurement mechanic, step by step
The sequence at each reporting date is mechanical once the population is right.
| Step | What you recompute | Where the adjustment goes | Reference |
|---|---|---|---|
| 1 | Expected total returns from the sales still inside their return window, as units | Drives steps 2 and 3 | IFRS 15.B23 |
| 2 | Required refund liability equals expected returns at the price the customer will be refunded | Movement to revenue, up or down | IFRS 15.B24 |
| 3 | Required return asset equals expected returns at former carrying amount less recovery costs less expected value decrease | Movement to cost of sales | IFRS 15.B25 |
| 4 | Actual returns received in the period, settled against the balances | Refund liability to cash or credit; return asset to inventory | IFRS 15.B21 |
Order matters when you are reviewing someone else's file. Settle the actual returns first, then true up the remaining balances to the revised expectation. Doing it in the other order produces a correct closing balance sheet but an uninterpretable profit and loss analysis, because the settlement and the estimate revision get mixed into a single number.
Watch the refund price, not the sales price. Where returns are refunded at the original selling price, the refund liability is measured at that price. Where the policy gives a store credit at current price, or refunds net of a restocking fee, the liability is measured at the amount the entity actually expects to hand back. IFRS 15.55 measures the refund liability at "the amount of consideration received (or receivable) for which the entity does not expect to be entitled", which is the retained restocking fee only if the entity genuinely expects to keep it.
Retail returns in practice
Next plc reports under IFRS and its retail and online business carries a significant volume of customer returns. Its revenue accounting policy explains that revenue is recognised net of an estimate of goods that will be returned, with a corresponding liability recognised for the expected refunds and an asset recognised for the right to recover the goods from customers, measured by reference to the previous carrying amount of the inventory. The policy is a clean illustration of the IFRS 15.B21 structure operating at scale in a business where the return window and the reporting date routinely overlap.
Next plc, Annual Report and Accounts, year to January 2025, accounting policies for revenue.My view
My view is that the return asset is the single most useful control indicator in a retail revenue balance. It only exists if someone has a unit-level expected returns population, an inventory cost per unit and a recovery cost assumption. A company that can produce a defensible return asset almost certainly has a defensible refund liability. A company with no return asset is telling you, without meaning to, that its returns accrual is a top-side percentage applied to sales value.
Local FAQs
Can the return asset be measured at the price the goods will be resold for? No. IFRS 15.B25 anchors it to the former carrying amount. Measuring at resale value would recognise a profit on goods the entity has not yet got back and has not yet sold.
What if the returned goods have no resale value at all? Then the expected decrease in value equals the carrying amount and the return asset is nil. Only the refund liability is recognised, and the full cost of those units goes to cost of sales at the point of sale. Perishable food and hygiene products often fall here.
Does the return asset get tested for impairment under IFRS 9? No. It is not a financial asset and it is not a contract asset. Its measurement is set by IFRS 15.B25, which already builds in expected recovery costs and value decreases, and it is remeasured at each reporting date under the same paragraph.
Potential risks
Recovery costs are routinely set at zero because nobody has isolated them. Free returns postage, third-party returns processing fees and warehouse handling are real costs of recovering the goods and belong in the IFRS 15.B25 deduction.
The expected decrease in value is often ignored on fashion and technology stock. A garment returned three weeks into a season is not worth its original cost, and a laptop returned opened is typically resold as an open-box item at a discount.
Where a group operates across territories with different statutory cooling-off periods, a single blended return rate can be materially wrong for individual entities in a consolidation, even if it is acceptable at group level.
3. Worked example: a retail sale with an expected return rate, all four legs and the remeasurement
This is an illustrative example constructed for this article, not a company's figures. It shows the sale entry with all four legs required by IFRS 15.B21, the settlement of actual returns, and the remeasurement at the reporting date when actual returns undershoot the estimate.
Facts
A retailer sells 1,000 identical units for cash on 1 December 20X5 at CU 100 each. The inventory cost of each unit is CU 60. Every customer has a 60-day right to return the goods for a full cash refund. On the basis of several years of stable data for this product line, the retailer expects 8 per cent of units to be returned. It expects to incur CU 3 per returned unit in carriage and handling to get the goods back, and expects each returned unit to be worth CU 2 less than its original cost because the packaging will have been opened. The retailer concludes, having considered IFRS 15.56 to 58, that no significant reversal of cumulative revenue is likely at the expected-value estimate, so the transaction price is not constrained further. Year end is 31 December 20X5. By that date 50 units have actually been returned and refunded, and the retailer now expects total returns of 65 units rather than 80.
Step 1: compute the four amounts before writing anything
| Amount | Working | CU | Reference |
|---|---|---|---|
| Cash received | 1,000 units at 100 | 100,000 | IFRS 15.B20 |
| Revenue | (1,000 less 80 expected returns) at 100 equals 920 at 100 | 92,000 | IFRS 15.B21(a) |
| Refund liability | 80 expected returns at the 100 refund price | 8,000 | IFRS 15.B21(b), 55 |
| Return asset | 80 at (60 cost less 3 recovery cost less 2 value decrease) equals 80 at 55 | 4,400 | IFRS 15.B25 |
| Inventory released | 1,000 at 60 | 60,000 | IAS 2 |
| Cost of sales | 60,000 less the 4,400 return asset | 55,600 | IFRS 15.B21(c) |
Check the cost of sales figure a second way, because this is where arithmetic slips. Cost of the 920 units expected to stay sold is 920 at 60 equals 55,200. Add the expected recovery costs and value decreases on the 80 units expected to come back, being 80 at 5 equals 400. Total 55,600. The two routes agree.
Step 2: the sale entry on 1 December 20X5
| Leg | Account | Dr CU | Cr CU | Reference |
|---|---|---|---|---|
| Cash | 100,000 | IFRS 15.B20 | ||
| 1 | Revenue | 92,000 | IFRS 15.B21(a) | |
| 2 | Refund liability | 8,000 | IFRS 15.B21(b) | |
| 3 | Cost of sales | 55,600 | IFRS 15.B21(c) | |
| 4 | Return asset (right to recover products) | 4,400 | IFRS 15.B25 | |
| Inventory | 60,000 | IAS 2 | ||
| Totals | 160,000 | 160,000 |
Gross profit recognised on the sale is 92,000 less 55,600 equals CU 36,400. Sense-check it against the underlying economics: 920 units at a margin of 40 gives 36,800, less the 400 of expected recovery costs and value decreases on the returning units, giving 36,400. The entry is internally consistent.
Step 3: 50 units are actually returned before the year end
Assume the actual recovery costs and value decrease on these units match the estimate of CU 5 each, so each unit goes back into inventory at CU 55.
| Account | Dr CU | Cr CU | Reference |
|---|---|---|---|
| Refund liability | 5,000 | 50 units at the 100 refund price | |
| Cash | 5,000 | Settlement of the refund obligation | |
| Inventory | 2,750 | 50 units at 55, the measured return asset per unit | |
| Return asset | 2,750 | IFRS 15.B25, asset realised on recovery |
After this entry the refund liability stands at 8,000 less 5,000 equals CU 3,000, and the return asset at 4,400 less 2,750 equals CU 1,650. Both balances still relate to the 30 units the original estimate said were still to come back.
Step 4: remeasurement at 31 December 20X5
The retailer now expects total returns of 65 units. Fifty have come back, so 15 more are expected, not 30. Both balances must be trued up.
| Balance | Carrying amount CU | Required amount CU | Adjustment CU | Goes to | Reference |
|---|---|---|---|---|---|
| Refund liability | 3,000 | 15 at 100 equals 1,500 | 1,500 credit to profit | Revenue | IFRS 15.B24 |
| Return asset | 1,650 | 15 at 55 equals 825 | 825 charge to profit | Cost of sales | IFRS 15.B25 |
| Account | Dr CU | Cr CU | Reference |
|---|---|---|---|
| Refund liability | 1,500 | IFRS 15.B24 | |
| Revenue | 1,500 | Adjustment recognised as revenue, not as other income | |
| Cost of sales | 825 | IFRS 15.B25 | |
| Return asset | 825 | Fewer products now expected to be recovered |
The net effect on profit is 1,500 less 825 equals CU 675 favourable. Prove it independently: the retailer now expects to keep 15 more units sold than it originally thought, and each unit carries a margin, on the IFRS 15 measurement basis, of 100 less 55 equals 45. Fifteen units at 45 is 675. The arithmetic holds.
Step 5: the closing position
| Line | CU | Comment |
|---|---|---|
| Revenue for the period | 93,500 | 92,000 at the sale plus the 1,500 remeasurement credit |
| Cost of sales for the period | 56,425 | 55,600 at the sale plus the 825 remeasurement charge |
| Gross profit | 37,075 | 36,400 plus 675 |
| Refund liability at 31 December 20X5 | 1,500 | 15 units at the 100 refund price |
| Return asset at 31 December 20X5 | 825 | 15 units at 55, presented separately from the liability |
Cross-check the gross profit against the units. Of the original 1,000, the retailer now expects 935 to stay sold at a margin of 40, giving 37,400, less the 5 per unit of recovery cost and value decrease on the 65 units it expects back, being 325. That gives 37,075. Matches.
The wrong answer, side by side
The two-leg version books revenue of 92,000 and a refund liability of 8,000, then charges the whole 60,000 of inventory to cost of sales. Here is what it does to the reported numbers at the date of sale.
| Line at 1 December 20X5 | Two-leg version CU | IFRS 15.B21 version CU | Error |
|---|---|---|---|
| Revenue | 92,000 | 92,000 | None |
| Cost of sales | 60,000 | 55,600 | Overstated by 4,400 |
| Gross profit | 32,000 | 36,400 | Understated by 4,400 |
| Gross margin | 34.8 per cent | 39.6 per cent | Understated by 4.8 points |
| Return asset | Nil | 4,400 | Asset omitted |
The error reverses when the goods come back, because the two-leg preparer credits cost of sales as the returned units are restored to inventory. That reversal is the tell. If cost of sales moves in the opposite direction to sales volumes in the month after a heavy returns period, the returns accounting is probably running on two legs.
Local FAQs
Should the remeasurement credit be shown separately from revenue? IFRS 15.B24 requires it to be recognised as revenue or as a reduction of revenue. Whether it is disaggregated on the face or in the notes is a presentation judgement, informed by IFRS 15.114 on disaggregation and by materiality.
What if the actual recovery cost turns out higher than estimated? The difference is a cost of sales item in the period in which it is identified, either as part of the IFRS 15.B25 remeasurement of the remaining asset or as an inventory costing difference on the units actually recovered.
Does the entity recognise a receivable rather than cash where the sale is on credit? Yes, and IFRS 15.108 confirms that a receivable can be recognised even though the amount may be subject to refund in the future. The refund liability sits alongside it and is not netted against it.
Potential risks
A blended return rate applied to a mixed basket can be materially wrong at line-of-business level even where it is broadly right in total, which matters for segment reporting and for any covenant tested on a divisional result.
Where the sales occur close to the reporting date, almost the whole return window falls after year end, so nearly the entire estimate is unsettled. That concentrates estimation risk into the most judgemental period of the year.
Bonus and commission schemes calculated on gross sales before the returns adjustment create a structural incentive to under-estimate the return rate. That is a fraud risk factor worth naming in the audit planning memorandum.
4. When is an exchange not a return?
Two exclusions sit at the end of the return guidance. A like-for-like exchange is not a return at all (IFRS 15.B26), and an exchange of a defective product for a functioning one is routed to the warranty guidance rather than the return guidance (IFRS 15.B27). Both exclusions change the accounting materially, so they are worth applying deliberately rather than by default.
"Exchanges by customers of one product for another of the same type, quality, condition and price (for example, one colour or size for another) are not considered returns for the purposes of applying this Standard."
All five attributes have to hold: same type, same quality, same condition, same price. A blue shirt swapped for the identical shirt in green, or a size 10 for a size 12, is not a return. No refund liability arises, no return asset arises, and revenue is unaffected. Economically nothing has happened except that a different unit of identical inventory has moved. The only accounting consequence is within inventory, where the returned item goes back to stock and the replacement comes out.
The exclusion is narrower than it looks in practice. If the customer swaps a size 10 shirt for a size 12 in a different style at the same price, the products are not of the same type and IFRS 15.B26 does not apply. If the customer swaps for a higher-priced item and pays the difference, the price attribute fails. Retail systems that treat every swap as an exchange, without testing type and price, will understate the returns population.
"Contracts in which a customer may return a defective product in exchange for a functioning product shall be evaluated in accordance with the guidance on warranties in paragraphs B28–B33."
This is the hinge between the two halves of this article. A customer returning goods because they changed their mind is exercising a right of return, and the entity applies IFRS 15.B20 to B25. A customer returning goods because the goods do not work is making a warranty claim, and the entity applies IFRS 15.B28 to B33. The economics differ. In the first case the entity expects to keep the cash but not the sale. In the second case the entity keeps the sale and incurs a cost to make good.
The consequence is that a defective-product exchange typically produces no revenue adjustment at all. Where the warranty is assurance-type, the cost of the replacement is charged against the IAS 37 warranty provision. Revenue stays where it was, because the entity has satisfied its performance obligation to deliver a product that complies with the agreed specification, albeit at the second attempt.
Splitting one returns population into two
Most consumer businesses receive both kinds of return through the same door. The customer service system usually captures a reason code, and that reason code is the evidence base for the split. In review, the questions are whether the reason codes are complete, whether "faulty" is being used as a catch-all by staff who want to authorise a refund quickly, and whether the split has been tested against the actual disposition of the returned goods. Goods that go back on the shelf at full price were probably not faulty. Goods that go to a repair or scrap route probably were.
| Scenario | Which guidance | Effect on revenue | Balance sheet effect | Reference |
|---|---|---|---|---|
| Customer changes mind, wants money back | Right of return | Revenue reduced for expected returns | Refund liability and return asset | IFRS 15.B20 to B25 |
| Customer swaps a red item for the identical blue item at the same price | Neither, this is not a return | None | Inventory movement only | IFRS 15.B26 |
| Customer swaps for a different product at a different price | Right of return on the original sale, new sale for the replacement | Original sale reversed, new revenue recognised | Refund liability and return asset arise | IFRS 15.B20, B26 by exclusion |
| Customer returns a faulty item for a working one | Warranty guidance | None if assurance-type | Utilisation of the IAS 37 warranty provision | IFRS 15.B27, B30 |
| Customer returns a faulty item and demands a refund under statute | Right of return, because the outcome is a refund not an exchange | Revenue reduced | Refund liability and return asset | IFRS 15.B20(a) |
The last row catches people out. IFRS 15.B27 routes defective-product exchanges to the warranty guidance. Where the statutory remedy the customer actually takes is a refund rather than a replacement, the entity is refunding consideration, and the substance is a right of return within IFRS 15.B20(a). The classification follows the remedy taken, not the reason for the claim.
Local FAQs
Does a like-for-like exchange affect the returns estimate? Not directly, because IFRS 15.B26 removes it from the returns population. It can still affect the estimate indirectly, because a rising exchange rate on a product line is often an early signal of a quality problem that will later show up as faulty returns.
What if the entity offers a replacement but the customer has to pay a fee? Then the price attribute in IFRS 15.B26 is not met and the transaction is not a like-for-like exchange. It is a return of the original product combined with a new sale.
How does this interact with a service-type warranty? If the replacement is delivered under a separately purchased extended plan, the cost of the replacement is a cost of satisfying that performance obligation, not a utilisation of an assurance provision. The revenue side is the release of the allocated transaction price over the plan period, dealt with in unit 8.
Potential risks
Reason codes are entered by front-line staff under time pressure and are rarely validated. An unreliable split between change-of-mind and faulty returns means both the returns estimate and the warranty provision are built on the same weak data.
Where a group standardises its returns policy but its jurisdictions have different statutory remedies, the mix of refunds and replacements varies by country even for identical products, which affects the split between IFRS 15.B20 and IFRS 15.B27 treatment.
5. What are the two warranty types under IFRS 15, and why is there no third?
IFRS 15 recognises assurance-type warranties and service-type warranties. An assurance-type warranty promises that the product complies with agreed-upon specifications. It is not a performance obligation and is accounted for under IAS 37 (IFRS 15.B30). A service-type warranty promises a service in addition to that assurance. It is a performance obligation and takes an allocation of the transaction price (IFRS 15.B32). There is no third category.
"It is common for an entity to provide (in accordance with the contract, the law or the entity's customary business practices) a warranty in connection with the sale of a product (whether a good or service). The nature of a warranty can vary significantly across industries and contracts. Some warranties provide a customer with assurance that the related product will function as the parties intended because it complies with agreed-upon specifications. Other warranties provide the customer with a service in addition to the assurance that the product complies with agreed-upon specifications."
Three details in this paragraph do real work. First, a warranty can arise from the contract, from the law, or from customary business practice. An unwritten but consistently honoured practice of replacing failed goods creates a warranty for accounting purposes even where the contract is silent, consistent with IFRS 15.24 on implied promises. Second, warranties attach to services as well as to goods. A money-back service guarantee on a professional service is within the same guidance. Third, the paragraph describes exactly two things a warranty can provide: assurance, and a service in addition to assurance.
"If a customer does not have the option to purchase a warranty separately, an entity shall account for the warranty in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets unless the promised warranty, or a part of the promised warranty, provides the customer with a service in addition to the assurance that the product complies with agreed-upon specifications."
The default for a warranty that cannot be bought separately is IAS 37. That means a provision is recognised where there is a present obligation from a past event, an outflow is probable, and a reliable estimate can be made, measured at the best estimate of the expenditure required to settle the obligation. The obligating event is the sale of the defective product, which is why the provision goes up as sales are made rather than as claims arrive. No part of the transaction price is allocated to an assurance-type warranty, so it never appears in the step 4 allocation.
The word "unless" carries the exception, and the words "or a part of the promised warranty" carry the possibility of a split. One warranty clause can contain both an assurance element and a service element, and IFRS 15.B32 requires the service element to be treated as a performance obligation where the two can reasonably be accounted for separately.
"If a warranty, or a part of a warranty, provides a customer with a service in addition to the assurance that the product complies with agreed-upon specifications, the promised service is a performance obligation. Therefore, an entity shall allocate the transaction price to the product and the service. If an entity promises both an assurance-type warranty and a service-type warranty but cannot reasonably account for them separately, the entity shall account for both of the warranties together as a single performance obligation."
The second sentence is the practical fallback and it deserves attention because it is drafted the way round that most preparers do not expect. Where the two elements cannot reasonably be separated, the standard does not tell you to treat the whole thing as an IAS 37 provision. It tells you to treat both together as a single performance obligation. In other words, the service treatment prevails when separation fails, and revenue is allocated to the combined warranty. That is the conservative outcome from a revenue timing perspective, because it defers revenue rather than recognising it and providing for a cost.
The fallback should be a genuine last resort. "Cannot reasonably account for them separately" is a higher bar than "would be inconvenient to separate". Where an entity sells a similar assurance-only warranty on other product lines, or where an observable market price exists for the service element, separation is normally practicable and the fallback is not available.
The term "performance warranty" does not exist in IFRS 15. The standard uses "assurance-type warranty" and "service-type warranty" and nothing else (IFRS 15.B32). A paper that reaches for "performance warranty" has usually skipped the assurance versus service test, because the label describes what the warranty covers rather than what it promises the customer. Reviewers should treat the phrase as a prompt to reopen the analysis.
What each treatment does to the numbers
| Feature | Assurance-type | Service-type | Reference |
|---|---|---|---|
| Is it a performance obligation? | No | Yes | IFRS 15.B30, B32 |
| Does it take an allocation of the transaction price? | No | Yes, on a relative stand-alone selling price basis | IFRS 15.74, B32 |
| What appears on the balance sheet at the date of sale? | A provision for expected warranty costs | A contract liability for the allocated consideration | IAS 37, IFRS 15.106 |
| Where does the initial charge go? | Cost of sales, as an expense | Nowhere; revenue is deferred instead | IAS 37, IFRS 15.B32 |
| How is revenue recognised? | All at the point of sale of the product | Over the warranty service period | IFRS 15.31, 35 |
| What happens when a claim is made? | Cost charged against the provision | Cost expensed as incurred; revenue released on the measure of progress | IAS 37, IFRS 15.39 |
| Effect on reported margin at sale | Margin recognised in full, reduced by the provision charge | Part of the price and its margin deferred | IFRS 15.B30, B32 |
The two treatments can produce very different profiles even where the total cash and the total profit over the life of the arrangement are identical. Assurance-type recognises all the revenue immediately and takes a cost charge immediately. Service-type recognises less revenue immediately and spreads the rest. On a growing product line the difference is not just timing at the individual contract level, it is a persistent difference in reported revenue, because each period's deferral exceeds the release from earlier periods.
Practitioner note
A useful sanity question when the classification is disputed: what would the customer say they had bought? If the honest answer is "a working product", the warranty is assurance. If the honest answer is "a working product plus five years of on-site engineer visits and preventive servicing", there is a service element. Customers do not usually think of statutory quality rights as something they bought, which is one reason IFRS 15.B31(a) treats a legal requirement as an indicator of assurance.
Local FAQs
Can a single warranty clause contain both types? Yes. IFRS 15.B30 and B32 both refer to "a part of the promised warranty", so a five-year warranty can be assurance for the defects it covers and service for the annual servicing visits it also promises.
Is a free repair within the statutory period a performance obligation? Normally not. IFRS 15.B31(a) says that a legal requirement to provide a warranty indicates the promise is not a performance obligation, and IFRS 15.B30 then routes it to IAS 37.
Does a longer warranty automatically mean service-type? No. Length is one of three factors in IFRS 15.B31, not a rule. A ten-year structural warranty on a building product may still be pure assurance if all it promises is that the product will meet its specification.
Potential risks
Classification is often set once at product launch and never revisited, even where the warranty terms have been extended for commercial reasons. A warranty that was assurance-type at two years may have acquired a service element by the time it is marketed at seven.
Groups with decentralised commercial teams frequently end up with the same product carrying different warranty terms in different territories. A single group accounting policy that names one classification is then wrong somewhere.
Where the fallback in IFRS 15.B32 is applied, the effect is to defer revenue on the whole warranty. Applying it loosely, simply to avoid the work of separation, systematically understates current period revenue and is not what the paragraph contemplates.
6. How do you decide which warranty you have?
Start with one question: can the customer buy the warranty separately? If yes, it is a distinct service and a performance obligation, and the analysis stops there (IFRS 15.B29). Only if the answer is no do you weigh the three factors in IFRS 15.B31: whether the warranty is required by law, how long the coverage period is, and what tasks the entity has promised to perform.
"If a customer has the option to purchase a warranty separately (for example, because the warranty is priced or negotiated separately), the warranty is a distinct service because the entity promises to provide the service to the customer in addition to the product that has the functionality described in the contract. In those circumstances, an entity shall account for the promised warranty as a performance obligation in accordance with paragraphs 22–30 and allocate a portion of the transaction price to that performance obligation in accordance with paragraphs 73–86."
This is the cleanest test in the whole of Appendix B and it is decisive. The standard does not say that a separately purchasable warranty is likely to be a service. It says the warranty is a distinct service, and that the entity shall account for it as a performance obligation. There is no further judgement to exercise once the condition is met.
Two triggers are given as examples: the warranty is priced separately, or it is negotiated separately. Priced separately is the easy case, and it is why every extended warranty sold at a checkout for a stated price is a performance obligation. Negotiated separately is the harder case and matters in business-to-business contracts where a customer bargains a longer coverage period in exchange for a higher contract price without a separate line item ever appearing on the invoice. If the coverage was negotiated, it was purchasable, and IFRS 15.B29 applies.
Note also that the availability of the option is what counts, not whether this particular customer took it. A customer who declines the extended plan has not bought a performance obligation, so no allocation arises for that contract. But the existence of the separately priced plan is powerful evidence about what the bundled coverage on other contracts represents, and it gives the entity an observable stand-alone selling price for the service element when one is needed.
Where the warranty is not separately purchasable, IFRS 15.B31 requires the entity to consider factors such as the following in assessing whether the warranty provides a service in addition to assurance.
Whether the warranty is required by law. The standard explains that "if the entity is required by law to provide a warranty, the existence of that law indicates that the promised warranty is not a performance obligation because such requirements typically exist to protect customers from the risk of purchasing defective products." A statutory minimum warranty is therefore an indicator of assurance, not of service. The reasoning is that consumer protection law exists to guarantee a baseline of quality rather than to confer a distinct service on the buyer.
The length of the warranty coverage period. The standard explains that "the longer the coverage period, the more likely it is that the promised warranty is a performance obligation because it is more likely to provide a service in addition to the assurance that the product complies with agreed-upon specifications." The logic is that a defect present at delivery will normally reveal itself early. Coverage that runs for years beyond the point at which a latent manufacturing defect would emerge starts to look like insurance or maintenance rather than assurance.
The nature of the tasks the entity promises to perform. The standard explains that "if it is necessary for an entity to perform specified tasks to provide the assurance that a product complies with agreed-upon specifications (for example, a return shipping service for a defective product), then those tasks likely do not give rise to a performance obligation." Tasks that exist only to deliver the assurance, such as collecting a faulty item, are part of the assurance. Tasks that go beyond it, such as scheduled preventive maintenance, software feature updates, on-site engineer visits or accidental damage cover, are the hallmark of a service.
The word "such as" matters. The three factors are not an exhaustive list and none of them is individually determinative. A warranty can be required by law and still contain a service element, if the entity has promised tasks beyond what the law requires. The assessment is made on the substance of what has been promised.
"A law that requires an entity to pay compensation if its products cause harm or damage does not give rise to a performance obligation. For example, a manufacturer might sell products in a jurisdiction in which the law holds the manufacturer liable for any damages (for example, to personal property) that might be caused by a consumer using a product for its intended purpose. Similarly, an entity's promise to indemnify the customer for liabilities and damages arising from claims of patent, copyright, trademark or other infringement by the entity's products does not give rise to a performance obligation. The entity shall account for such obligations in accordance with IAS 37."
This paragraph removes two things from the revenue model entirely. Product liability under general law is not a promise to the customer about the product's specification; it is a legal exposure to third-party harm. And an intellectual property indemnity, which appears in almost every software and technology contract, is not a promised service either. Both go to IAS 37, which for most entities means a contingent liability disclosure rather than a provision, because an outflow is not usually probable at the reporting date.
The practical importance is that neither reduces revenue. A software vendor allocating part of its licence fee to its IP indemnity is misapplying the standard. The indemnity is not a performance obligation, so it cannot receive an allocation under IFRS 15.74. This point matters when reading the promises in licences of intellectual property, where indemnities are standard drafting.
Consumer electronics: two warranties, two accounting answers
Apple Inc. discloses both patterns in the same filing. Its standard hardware warranty is accrued for at the time the related revenue is recognised, based on historical and projected product failure rates and repair costs, which is the assurance-type treatment: a cost provision, no revenue deferral. Separately, Apple sells AppleCare extended service and support plans, and the consideration for those plans is deferred and recognised over the service coverage period, which is the service-type treatment: a performance obligation carrying an allocation of the transaction price. The plans are sold at a separate price, which is precisely the fact pattern IFRS 15.B29 describes as decisive. Apple reports under US GAAP, and the assurance versus service distinction in ASC 606 mirrors IFRS 15 on this point.
Apple Inc., Form 10-K for the fiscal year ended 28 September 2024, summary of significant accounting policies.My view
My view is that the B29 test is under-used in review. Practitioners reach straight for the three B31 factors and start weighing them, when in many cases the entity already publishes a price list for the extended plan and the answer is settled before the factors are opened. Where a separate price exists, the debate is over. Where it does not, the factors are a genuine judgement and should be documented as one, with the specific tasks promised listed out rather than described in the abstract.
Local FAQs
Does the customer have to actually buy the warranty for IFRS 15.B29 to bite? IFRS 15.B29 turns on whether the customer "has the option to purchase a warranty separately". Where a customer takes the bundled coverage and there is a separately purchasable equivalent, that coverage is a distinct service and a performance obligation arises in that contract.
What if the warranty is free but the entity also sells the same coverage separately? A free extended warranty bundled with the product is still a promised service, and its stand-alone selling price is observable from the separate sales. It is a performance obligation and receives an allocation, which reduces the revenue allocated to the product.
Do the three B31 factors have a hierarchy? No. IFRS 15.B31 introduces them as "factors such as", so they are indicators to be weighed together, and other relevant factors can be considered.
Where does an IP indemnity go in a software contract? To IAS 37, under IFRS 15.B33. It is not a performance obligation and receives no allocation.
Potential risks
Bundled coverage sold as "free" is frequently omitted from the performance obligation inventory altogether, because nothing was invoiced for it. Nothing in IFRS 15.B29 requires the warranty to have been charged for separately in the contract; it requires that the option to purchase it separately exists.
Where the entity relies on the IFRS 15.B32 fallback, the file should evidence why separation is not reasonably possible. Absent that evidence, the fallback looks like a shortcut and is difficult to defend to a regulator.
Business-to-business contracts negotiated by sales teams may include extended coverage that never reaches the revenue accounting team, because it appears in a schedule rather than on the price page. Contract review procedures should look at schedules, not just headline pricing.
7. How do statutory warranties and consumer law affect the classification?
A warranty the entity is legally required to give points towards assurance-type, because IFRS 15.B31(a) treats the existence of the law as an indicator that the promise is not a performance obligation. Statutory coverage is therefore normally an IAS 37 provision. The judgement arises where the entity promises more than the law requires, because the excess can carry a service element.
Why a legal requirement points to assurance
The reasoning in IFRS 15.B31(a) is about purpose. Consumer protection legislation exists to guarantee that goods sold are of satisfactory quality and fit for purpose. It does not confer a distinct benefit that the customer bargained for and paid for; it sets the floor below which the seller cannot go. The standard states that such requirements "typically exist to protect customers from the risk of purchasing defective products", and concludes that their existence indicates the promised warranty is not a performance obligation. Since the customer could not have purchased the statutory protection separately, IFRS 15.B29 does not apply, and IFRS 15.B30 routes the coverage to IAS 37.
The consequence is that statutory coverage generates a provision rather than deferred revenue. The obligating event is the sale of goods that may prove defective, and the provision is recognised when the recognition criteria in IAS 37.14 are met: a present obligation from a past event, a probable outflow of resources embodying economic benefits, and a reliable estimate. For a large population of similar products, probability is assessed for the population as a whole rather than item by item, which is why a warranty provision is recognised even though the probability that any individual unit fails is low.
Measuring and running the provision
| Question | Treatment | Reference |
|---|---|---|
| When is the provision recognised? | At the point of sale of the product, being the obligating event | IAS 37.14 |
| At what amount? | The best estimate of the expenditure required to settle the present obligation at the reporting date | IAS 37.36 |
| How is a population of small claims measured? | By the expected value of the possible outcomes, weighted by probability | IAS 37.39 |
| Is it discounted? | Yes where the effect of the time value of money is material, using a pre-tax rate reflecting current market assessments and the risks specific to the liability | IAS 37.45, 47 |
| What happens at each reporting date? | The provision is reviewed and adjusted to the current best estimate | IAS 37.59 |
| Can claims be charged elsewhere? | No. The provision is used only for the expenditures for which it was originally recognised | IAS 37.61 |
| Where does the charge go? | Normally cost of sales, matching the product to which the obligation relates | IAS 37, IAS 1 presentation |
Note that the classification of the charge is a presentation question rather than a recognition question. Most manufacturers present warranty costs within cost of sales because the obligation arises directly from the goods sold. Presenting them as an administrative expense separates the cost from the revenue it relates to and usually makes the gross margin less informative. Entities preparing statements for periods beginning on or after 1 January 2027 will apply IFRS 18, which replaces IAS 1 and introduces mandatory subtotals and stricter aggregation principles, so warranty cost presentation will need to be revisited at that point.
Where statutory coverage and contractual coverage overlap
Most manufacturers give a contractual warranty longer than the statutory minimum. The two do not sit end to end; they overlap, because the statutory rights continue to run alongside the contractual promise. The analysis is easier if you separate what is promised from how long it lasts.
| Element promised | Likely classification | Reasoning | Reference |
|---|---|---|---|
| Repair or replacement of goods that were not of satisfactory quality when supplied, for the statutory period | Assurance-type | Required by law and limited to conformity with specification | IFRS 15.B31(a), B30 |
| The same repair or replacement promise, extended by contract to a longer period at no separate price | Judgement, weighing the length factor | The longer the coverage, the more likely a service is being provided | IFRS 15.B31(b) |
| Collection and return shipping of a faulty item | Assurance-type | The standard names return shipping for a defective product as a task that likely does not give rise to a performance obligation | IFRS 15.B31(c) |
| Scheduled preventive maintenance or annual servicing visits | Service-type | The tasks go beyond assurance of conformity with specification | IFRS 15.B31(c), B32 |
| Accidental damage cover | Service-type | Damage caused by the customer is not a failure to meet specification | IFRS 15.B32 |
| An extended plan the customer can buy at the till | Service-type, no judgement required | Separately purchasable | IFRS 15.B29 |
| Compensation payable by law if the product causes harm | Neither. Outside the revenue model | Does not give rise to a performance obligation | IFRS 15.B33 |
Longer does not mean service, automatically. IFRS 15.B31(b) is a factor, not a threshold. A twenty-five year warranty on roofing membrane that promises only that the membrane will meet its stated specification is arguably still assurance, because nothing is promised beyond conformity. What tips a long warranty into service territory is usually the tasks bundled with it, not the calendar.
Practitioner note
Read the warranty booklet, not the summary in the accounting paper. The distinction between assurance and service is almost always resolved by the list of what the entity will actually do, and that list lives in the customer-facing terms. In one common pattern the marketing headline says "five year warranty" while the terms reveal two years of full cover, followed by three years covering specified components only, with a customer contribution to labour. Those are different promises with potentially different classifications.
Where the warranty obligation becomes onerous
Where an assurance-type warranty is accounted for under IAS 37, a systemic product failure can push the expected cost of honouring warranties well above the provision previously recognised. That is dealt with by remeasuring the provision to the current best estimate under IAS 37.59, not by reversing revenue. Where an entity has instead committed to an unavoidable contract whose costs exceed the benefits, the onerous contract requirements in IAS 37.66 to 69 apply, and the cost of fulfilling the contract comprises the costs that relate directly to the contract as set out in IAS 37.68A, effective for annual periods beginning on or after 1 January 2022. The interaction is set out further in onerous contracts under IAS 37.
Local FAQs
Do statutory consumer rights create a refund liability as well as a warranty provision? They can. Where the statutory remedy the customer takes is a refund rather than a repair or replacement, the entity is refunding consideration and IFRS 15.B20(a) applies, producing a refund liability and a return asset rather than a warranty provision.
Should the warranty provision be discounted? Only where the effect of the time value of money is material (IAS 37.45). For a two-year consumer warranty it usually is not. For a ten-year structural warranty on a construction product it usually is.
Is a recall a warranty provision? A recall is normally a separate IAS 37 assessment. The obligating event and the population affected differ from routine warranty claims, and the provision should be recognised and disclosed separately where material.
Potential risks
Warranty provisions calculated as a fixed percentage of revenue and never back-tested against actual claims are common and are difficult to support under IAS 37.36. The test to apply is whether the provision recognised in prior years was subsequently used, over-provided or under-provided, and whether the model has been corrected.
Where a group sells the same product across jurisdictions with different statutory periods, a single warranty rate can be materially wrong at entity level even where it holds at group level.
Extending a warranty period for commercial reasons increases the provision for units already sold only if the extension creates a present obligation for those units. Applying the new rate retrospectively to the whole installed base without that analysis overstates the provision.
8. Worked example: a product with a statutory warranty and an optional extended plan
This is an illustrative example constructed for this article, not a company's figures. One contract contains an assurance-type warranty accounted for under IAS 37 and a service-type warranty accounted for as a performance obligation, and the example shows both the allocation and the recognition profile of each.
Facts
A manufacturer sells a machine on 1 January 20X1. The law in the customer's jurisdiction requires a two-year warranty against defects, and the manufacturer's contractual warranty matches that statutory minimum exactly and promises nothing beyond repair or replacement of non-conforming goods. The manufacturer also sells a three-year extended service plan, available separately at a list price of CU 2,000, which runs from the end of year 2 to the end of year 5 and includes annual preventive maintenance visits, priority engineer call-out and cover for wear-and-tear failures. The customer buys the machine and the extended plan together for a single price of CU 11,400. The stand-alone selling price of the machine on its own is CU 10,000. The machine's inventory cost is CU 6,000. The manufacturer estimates the expected cost of honouring the statutory warranty on this machine at CU 300, and expects to incur CU 300 of servicing costs in each of years 3, 4 and 5 under the plan.
Step 1: identify the performance obligations
| Promise | Analysis | Conclusion | Reference |
|---|---|---|---|
| The machine | A distinct good; the customer can benefit from it on its own and the promise is separately identifiable | Performance obligation 1 | IFRS 15.22, 27 |
| Two-year statutory warranty | Not separately purchasable, required by law, promises nothing beyond conformity with specification | Assurance-type. Not a performance obligation. IAS 37 provision | IFRS 15.B29 not met, B31(a), B30 |
| Three-year extended plan | Available for separate purchase at a stated price, and promises tasks beyond assurance | Service-type. Performance obligation 2 | IFRS 15.B29, B31(c), B32 |
The extended plan needs no weighing of factors. It is available for separate purchase at a list price, so IFRS 15.B29 settles it: the warranty is a distinct service and is accounted for as a performance obligation. The statutory warranty needs no weighing either, for the opposite reason. It cannot be bought separately, so IFRS 15.B30 applies, and IFRS 15.B31(a) confirms that the legal requirement indicates it is not a performance obligation.
Step 2: allocate the transaction price
Two performance obligations, so the transaction price of CU 11,400 is allocated on a relative stand-alone selling price basis under IFRS 15.74, with stand-alone selling prices determined at contract inception under IFRS 15.76. Both stand-alone selling prices are directly observable, so no estimation under IFRS 15.78 is required.
| Performance obligation | Stand-alone selling price CU | Proportion | Allocated transaction price CU |
|---|---|---|---|
| Machine | 10,000 | 10,000 / 12,000 equals 83.33 per cent | 11,400 at 10,000 / 12,000 equals 9,500 |
| Extended service plan | 2,000 | 2,000 / 12,000 equals 16.67 per cent | 11,400 at 2,000 / 12,000 equals 1,900 |
| Total | 12,000 | 100 per cent | 11,400 |
The customer received a bundle discount of CU 600 against the sum of the stand-alone selling prices. Because the discount is not attributable to a specific obligation under IFRS 15.82, it is spread proportionately, so the machine bears CU 500 of it and the plan bears CU 100. Nothing is allocated to the statutory warranty at any stage, because it is not a performance obligation. The mechanics of the allocation step are set out in full in allocating the transaction price.
Step 3: the entries on delivery, 1 January 20X1
| Account | Dr CU | Cr CU | Reference |
|---|---|---|---|
| Trade receivable | 11,400 | IFRS 15.108 | |
| Revenue, machine | 9,500 | IFRS 15.31, 38, allocated under 74 | |
| Contract liability, extended service plan | 1,900 | IFRS 15.106, service not yet provided | |
| Cost of sales, machine | 6,000 | IAS 2 | |
| Inventory | 6,000 | IAS 2 | |
| Cost of sales, warranty | 300 | Assurance-type charge | |
| Warranty provision | 300 | IAS 37.14, measured under IAS 37.36 | |
| Totals | 17,700 | 17,700 |
Notice what the two warranties do to the balance sheet on day one. The assurance-type warranty creates a provision of CU 300 with a matching charge to profit, and leaves revenue untouched. The service-type warranty creates a contract liability of CU 1,900 with no charge to profit at all, and reduces the revenue recognised on the machine. Same contract, same date, two entirely different balance sheet consequences, driven by the classification.
Step 4: the recognition profile of each warranty
The extended plan is a stand-ready obligation. The customer simultaneously receives and consumes the benefit of the manufacturer's readiness to service the machine, so the obligation is satisfied over time under IFRS 15.35(a). A time-based measure of progress is appropriate under IFRS 15.39 and 41 because the benefit of standing ready is spread evenly across the coverage period, and the manufacturer has no evidence that the effort required is materially concentrated in any part of it. Coverage runs for 36 months from 1 January 20X3.
| Year | Machine revenue CU | Plan revenue CU | Cost of sales CU | Warranty provision movement CU | Profit CU |
|---|---|---|---|---|---|
| 20X1 | 9,500 | Nil | 6,000 | 300 charge | 3,200 |
| 20X2 | Nil | Nil | Nil | 30 credit on remeasurement | 30 |
| 20X3 | Nil | 633.33 | 300 servicing | Nil | 333.33 |
| 20X4 | Nil | 633.33 | 300 servicing | Nil | 333.33 |
| 20X5 | Nil | 633.34 | 300 servicing | Nil | 333.34 |
| Total | 9,500 | 1,900 | 6,900 | 270 net charge | 4,230 |
The 20X2 credit assumes that actual claims of CU 270 were incurred and charged against the provision across 20X1 and 20X2, and that the residual CU 30 was released at the end of 20X2 when the statutory period expired and no further claims were possible. IAS 37.61 requires that the provision be used only for the expenditures for which it was originally recognised, so the release is a credit to the same line as the original charge. Prove the total: cash received 11,400, less machine cost 6,000, less net warranty cost 270, less plan servicing 900, equals 4,230. The table agrees.
The two wrong answers
Wrong answer one: allocating at stated prices. A preparer takes the plan's list price of CU 2,000 as the deferral and calls the balance of CU 9,400 machine revenue. That ignores IFRS 15.74, which requires allocation on a relative stand-alone selling price basis, and it forces the entire bundle discount onto the machine.
| Line at 1 January 20X1 | Stated-price method CU | IFRS 15.74 method CU | Error |
|---|---|---|---|
| Machine revenue | 9,400 | 9,500 | Understated by 100 |
| Contract liability | 2,000 | 1,900 | Overstated by 100 |
| Plan revenue per year in 20X3 to 20X5 | 666.67 | 633.33 | Overstated by 33.33 per year |
The error is small here because there are only two obligations and the discount is modest. Scale it to a contract with five obligations and a 30 per cent bundle discount and the same shortcut moves material amounts between periods.
Wrong answer two: allocating revenue to the statutory warranty. A preparer decides that because the statutory warranty is a promise to the customer, part of the price should be deferred against it, and carves out CU 300 of revenue into a contract liability. That contradicts IFRS 15.B30, which requires a warranty the customer cannot purchase separately to be accounted for under IAS 37 where it provides no service beyond assurance. The effect is to defer CU 300 of machine revenue that should have been recognised, and to omit the CU 300 provision charge, so profit in 20X1 is unchanged but revenue is understated by CU 300, cost of sales is understated by CU 300, and gross margin percentage is wrong. It also creates a liability of the wrong type, which then flows into the wrong disclosure note.
My view
My view is that the second error is more damaging than the first, even though it does not move the profit number. Revenue is the line most users focus on and the line most regulators question. A misclassified liability also travels: it appears in the contract liability reconciliation, in the remaining performance obligation disclosure under IFRS 15.120, and in the maturity analysis, and every one of those disclosures is then wrong. Errors that are profit-neutral are not disclosure-neutral.
Local FAQs
What if the extended plan runs concurrently with the statutory warranty rather than after it? The plan revenue is recognised over its own coverage period regardless, on the measure of progress that best depicts the transfer of the service. Overlapping cover may mean fewer claims fall on the plan in the early years, which is a costs question, not a revenue timing question.
Can the plan revenue be recognised on the pattern of expected claim costs instead of straight line? Only if that better depicts the transfer of the promised service under IFRS 15.39. For a stand-ready obligation the promise is availability rather than repair activity, so a cost-based pattern is usually not the right measure. The distinction between output and input measures is developed in over time versus point in time recognition.
Where does the CU 300 warranty charge sit in the income statement? Ordinarily in cost of sales, because it relates directly to the goods sold. It is not a reduction of revenue, because an assurance-type warranty is a cost of performing, not a variable element of the transaction price.
Potential risks
Where the extended plan is sold at a discount to list price in some channels, the list price may not be the stand-alone selling price. IFRS 15.77 warns that a contractually stated price or a list price may be, but shall not be presumed to be, the stand-alone selling price.
Multi-year plans create a long-dated contract liability that has to be split between current and non-current, and that has to be reconciled each period under IFRS 15.118. Entities that record the deferral in a single account with no maturity profile struggle to produce that disclosure.
If the plan can be cancelled with a pro-rata refund, the refund feature is a further element of the analysis, because unexercised cancellation rights and refunds interact with IFRS 15.55.
What regulators look for on returns, warranties and loyalty
These balances are estimates sitting on the face of the balance sheet, and they move with management assumptions. Regulators focus on whether the assumptions are disclosed and whether the estimate is genuinely revisited.
An entity shall disclose information about the methods, inputs and assumptions used for all of the following: determining the transaction price, which includes, but is not limited to, estimating variable consideration, adjusting the consideration for the effects of the time value of money and measuring non-cash consideration; assessing whether an estimate of variable consideration is constrained; allocating the transaction price, including estimating stand-alone selling prices of promised goods or services and allocating discounts and variable consideration to a specific part of the contract; and measuring obligations for returns, refunds and other similar obligations.
The final limb is explicit about returns and refunds, and it asks for methods, inputs and assumptions. A note stating that returns are estimated based on historical experience gives none of the three. The expected return rate, the basis of segmentation and the sensitivity are what the paragraph is asking for.
UK FRC, 2019 thematic review: assumptions behind the estimate
The FRC's thematic review of first-year IFRS 15 disclosures pressed companies to show the evaluation behind a judgement rather than assert the conclusion, finding that "one company disclosed that judgement was applied in determining whether revenue was recognised over time or at a point in time but did not detail its evaluation of when the customer obtained control."
Applied to loyalty programmes, the equivalent gap is a note that discloses a deferred revenue balance for points without disclosing the expected redemption rate. The redemption rate is the assumption the entire balance turns on, and a change of a few percentage points moves revenue materially in both the current and future periods.
Financial Reporting Council, IFRS 15 Revenue from Contracts with Customers: Disclosures in the First Year of Application, thematic review, 2019.The four-leg discipline
A sale with a right of return is four entries, not two. Revenue at the amount expected to be entitled, a refund liability under IFRS 15.B21, a return asset under IFRS 15.B25 measured at the former carrying amount of the inventory less expected recovery costs, and the matching reduction in cost of sales. The audit of the earlier version of this cluster found the last two missing, which overstates cost of sales and understates assets by the full cost of goods expected back.
My view: the return asset is the leg that disappears in practice, usually because the systems post returns through inventory only on physical receipt. The reporting-date estimate has to be made whether or not the goods have come back, and a returns provision that never carries a corresponding asset is a good indicator that the estimate is being made in the wrong place.
What goes wrong most often
Five patterns: two-leg return journals, the return asset measured at selling price, assurance-type warranties allocated revenue, loyalty points treated as a marketing cost, and breakage recognised only on expiry.
- Return journals with two legs. Revenue and a refund liability, with no return asset and no cost of sales adjustment. IFRS 15.B25 requires the asset for the right to recover the goods, and omitting it misstates both the balance sheet and gross margin.
- The return asset measured at selling price. IFRS 15.B25 measures it by reference to the former carrying amount of the inventory, less expected costs to recover and any expected reduction in value. Measuring it at the refund amount books an unearned margin on goods that were never sold.
- Assurance-type warranties allocated revenue. An assurance-type warranty is not a performance obligation. It is a cost accrual under IAS 37. Allocating transaction price to it defers revenue that has been earned and creates a liability the standard does not contemplate.
- Loyalty points expensed as marketing. Where points give the customer a material right under IFRS 15.B39 to B43, part of the original transaction price is allocated to them and deferred. Treating the eventual redemption as a cost of sale recognises revenue too early and understates the contract liability throughout.
- Breakage recognised only on expiry. IFRS 15.B46 requires breakage to be recognised in proportion to the pattern of rights exercised where the entity expects to be entitled to a breakage amount. Holding the whole balance until expiry defers revenue the standard says has been earned.
Frequently asked questions
What is the difference between an assurance-type and a service-type warranty under IFRS 15?
An assurance-type warranty gives the customer assurance that the product complies with agreed-upon specifications. It is not a performance obligation and is accounted for as a provision under IAS 37 (IFRS 15.B30). A service-type warranty gives the customer a service in addition to that assurance. It is a performance obligation and part of the transaction price is allocated to it (IFRS 15.B32). Those are the only two categories in the standard.
What are the four journal legs for a sale with a right of return under IFRS 15?
Revenue for the amount of consideration to which the entity expects to be entitled, a refund liability for the amounts it does not expect to be entitled to, a return asset for the right to recover products from customers, and a corresponding adjustment to cost of sales (IFRS 15.B21). A two-leg entry that shows only net revenue and a refund liability is incomplete.
How is the return asset measured under IFRS 15?
By reference to the former carrying amount of the product, less any expected costs to recover those products, including potential decreases in the value to the entity of returned products (IFRS 15.B25). It is never measured at selling price, and it is presented separately from the refund liability.
Is an extended warranty always a performance obligation under IFRS 15?
If the customer has the option to purchase the warranty separately, for example because it is priced or negotiated separately, the warranty is a distinct service and is accounted for as a performance obligation (IFRS 15.B29). That test is decisive. Where there is no separate purchase option, the entity applies the factors in IFRS 15.B31 instead.
Does IFRS 15 use the term performance warranty?
No. IFRS 15.B28 to B33 recognise assurance-type and service-type warranties only. Performance warranty is not a term used in the standard and using it in an accounting paper signals that the assurance versus service analysis has not been performed.
When does a customer option create a material right under IFRS 15?
When the option provides a right the customer would not receive without entering into that contract, for example a discount that is incremental to the range of discounts typically given for those goods or services to that class of customer in that geographical area or market (IFRS 15.B40). An option priced at the stand-alone selling price of the future good or service is a marketing offer, not a material right (IFRS 15.B41).
How are loyalty points accounted for under IFRS 15?
Points that give a material right are a performance obligation. Part of the transaction price is allocated to them on a relative stand-alone selling price basis (IFRS 15.74), with the stand-alone selling price of the option estimated by reference to the discount the customer would obtain, adjusted for discounts available without the option and for the likelihood of exercise (IFRS 15.B42). Revenue is recognised as points are redeemed or when they expire (IFRS 15.B40).
Are non-refundable upfront fees recognised as revenue when received?
Usually not. A joining, activation or set-up fee is normally an advance payment for future goods or services and is recognised as revenue when those goods or services are provided (IFRS 15.B49). The recognition period extends beyond the initial contractual period where a renewal option gives the customer a material right.
When is breakage on gift cards recognised as revenue under IFRS 15?
If the entity expects to be entitled to a breakage amount, it recognises that amount as revenue in proportion to the pattern of rights exercised by the customer. If it does not expect to be entitled to breakage, it recognises the amount when the likelihood of the customer exercising its remaining rights becomes remote (IFRS 15.B46). Amounts that must be remitted to another party under unclaimed property laws are recognised as a liability and not as revenue (IFRS 15.B47).
Is a promise to indemnify a customer for patent infringement a performance obligation?
No. An entity's promise to indemnify the customer for liabilities and damages arising from claims of patent, copyright, trademark or other infringement by the entity's products does not give rise to a performance obligation and is accounted for under IAS 37 (IFRS 15.B33).
Key takeaways
- A sale with a right of return has four legs: revenue, refund liability (IFRS 15.B21), return asset (IFRS 15.B25) and the cost of sales adjustment. Two-leg entries are incomplete.
- There are exactly two warranty types. Assurance-type is an IAS 37 provision; service-type is a performance obligation. The term "performance warranty" does not exist in IFRS 15.
- IFRS 15.B29 is the cleanest test available: if the customer could buy the warranty separately, it is a distinct service and a performance obligation.
- A customer option is only accounted for separately where it confers a material right (IFRS 15.B39 to B43). Then part of the transaction price is allocated to it and deferred.
- Non-refundable upfront fees are almost never separate obligations and may extend the recognition period beyond the stated contract term (IFRS 15.B48 to B51).
- Breakage is recognised in proportion to redemptions where entitlement is expected (IFRS 15.B46), not held until the rights expire.
About the Author
Usman is an ACCA-qualified member and an audit and financial reporting professional with a decade of Big 4 experience across Deloitte UK, PwC and BDO, currently an Assistant Manager in Deloitte UK's AI-enabled audit practice. He leads statutory and group audit engagements for multinational clients, with a portfolio in the £20m to £30m fee range and teams of 15 to 25 people across multiple jurisdictions. His technical work concentrates on the judgemental end of the accounting and audit standards. Sector exposure spans banking and financial services, automotive, technology, media and telecom, pharmaceuticals and healthcare, and private equity. Alongside audit delivery he advises CFOs and audit committees on adoption and disclosure decisions, and supports audit partners in forming audit opinions. He has coached more than 150 audit professionals to date, and delivers technical training on accounting and audit standards as well as on new AI tools. He also serves as an AI accelerator at Deloitte, testing new audit technology on live engagements, and built the AI platform behind this site. He writes here on the technical judgements that do not have a straightforward answer in the standards, adding an expert view formed in Big 4 practice.
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