This session was held jointly with the FASB.
The boards discussed three topics:
- warranties and product liability
- rights of return
- estimates of uncertain consideration.
Warranties and product liability
- reconsidered whether all product warranties give rise to separate performance obligations, as proposed in the Discussion Paper Preliminary Views on Revenue Recognition in Contracts with Customers;
- considered whether product liability laws give rise to performance obligations.
The boards decided tentatively that:
If the objective of a warranty is to provide a customer with cover for latent defects (ie those that exist when the asset is transferred to the customer but which are not yet apparent), that warranty does not give rise to a separate performance obligation. Instead it acknowledges the possibility that the entity has not satisfied its performance obligation to transfer the asset specified in the contract. Therefore, on the basis of all the available evidence, the entity would determine at the end of the reporting period the likelihood and extent of defects in the assets it has sold to customers and, hence, the amount of unsatisfied performance obligations with respect to those assets. Consequently:
(a) if the entity will be required to replace defective assets, it does not recognise revenue for those assets;
(b) if the entity will be required to repair defective assets, it does not recognise the portion of revenue that can be attributed to components that need to be replaced in the repair process.
If the objective of a warranty is to provide a customer with cover for faults that arise after the product is transferred to the customer, that warranty gives rise to a separate performance obligation. Therefore, the entity allocates part of the transaction price to that warranty performance obligation.
If the law requires an entity to pay compensation if its products cause harm or damage, that requirement does not give rise to a performance obligation. The entity accounts for such obligations in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets or FASB Accounting Standards Codification Subtopic 450-20 Loss Contingencies.
Rights of return
The boards considered how an entity should account for the sale of goods with a right of return. The boards decided tentatively that:
- An entity should not recognise revenue for the goods that are expected to be returned, but instead should recognise a refund liability for the expected (probability-weighted) amount of refunds to customers.
- Subsequently, an entity should update the refund liability for changes in expectations about the amount of refunds and make a corresponding adjustment to the amount allocated to the performance obligations.
- An entity should recognise an asset (and corresponding adjustment to cost of sales) for its right to recover goods from customers on settling the refund liability, initially measured at the original cost of the goods (that is, the former carrying amount in inventory).
- The promised return service should not be accounted for as a separate performance obligation in addition to the refund obligation.
Estimates of uncertain consideration
The boards considered when an entity should include estimated amounts of uncertain consideration in the transaction price and hence recognise those amounts as revenue when it satisfies performance obligations in a contract. The boards decided tentatively that:
An entity should include an estimated amount of uncertain consideration in the transaction price only if it can identify the possible outcomes of a contract (ie consideration amounts) and reasonably estimate the probabilities of those outcomes.
In the context of revenue recognition, an entity can identify the possible outcomes of a contract and reasonably estimate the related probabilities only if it:
(a) has experience with identical or similar types of contracts, and
(b) does not expect circumstances surrounding those types of contracts to change significantly.
The Exposure Draft should provide some factors for an entity to consider when assessing whether to include estimated consideration amounts in the transaction price.
At their January joint meeting, the boards plan to consider disclosure and scope.