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Rights of Return and Customer Acceptance in ASC 606

Under ASC 606, rights of return are generally treated as variable consideration, though the accounting may differ depending on the type of contract.

Brett Riley
Kathrine Jensen
Published:
May 16, 2020
Updated:
Oct 10, 2026

Many entities allow customers to return goods for any reason within a specified timeframe. Returns can be made in exchange for a full or partial refund, store credit, another product, or some combination of the above. Sales with a right of return create accounting issues because the amount of consideration to which the entity will ultimately be entitled is uncertain.

Many entities also offer customers a trial period or the option to accept or reject delivered goods based on either subjective preferences or clearly defined objective criteria. These return provisions are referred to as customer acceptance rights. Although customer acceptance rights appear similar to a right of return, these two notions are treated differently in ASC 606. Rights of return affect the estimate of the transaction price (step three) to be allocated among performance obligations, while customer acceptance rights affect the determination of when control transfers (step five). See The Five-Step Method for more information.

Rights of Return

ASC 606 requires that rights of return be treated as variable consideration. Upon transfer of control, an entity that has entered into a contract with a right of return should recognize:

  1. revenue in the amount of consideration the entity expects to receive after returns are made,
  2. a refund liability for the amount the entity expects to return to the customer, and
  3. an asset for the goods the entity expects to receive from the customer.

Revenue is recognized only for the portion of the sale that the entity expects to retain. The portion expected to be returned is recorded as a refund liability. An asset should also be recognized for the entity’s right to recover goods expected to be returned, measured at the former carrying amount of the inventory less any expected recovery costs and reductions in value. Inventory costs that exceed this expected return value of the inventory should be expensed as cost of goods sold.

With this method, revenue recognized at the point of the original sale does not include amounts to which the entity does not expect to be entitled, and the refund asset is not overvalued. When the return period expires, any remaining refund liability is recognized as revenue, and the related refund asset is either reclassified to inventory or recognized in cost of goods sold.

Entities must follow all of the guidance for variable consideration when accounting for rights of return, including applying the constraint. This does not necessarily require a two-step process of estimating returns and then separately applying the constraint. As explained by the FASB in ASU 2014-09, a separate evaluation of the constraint is unnecessary if the entity’s estimate of expected returns already reflects the level at which it is probable that a significant revenue reversal will not occur. See Variable Consideration and the Constraint for more information.

 
George Risk Industries, Inc. SEC Correspondence
 
   
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George Risk Industries, Inc. (George Risk) provides a variety of magnetic reed switches made in the USA. In a comment letter in March 2020, the SEC sent George Risk the following request:

You disclose that you recognize product returns as they are received. Please explain to us how this is consistent with the guidance in ASC 606-10-55-22 through 29, or revise your future filings to clearly disclose your compliance with that guidance.

George Risk responded to the inquiry about its dealings with returns, explaining the process of how it accounted for returns under the guidance found in the Codification:

In accordance with ASC 606-10-55-22 through 29, a refund liability should be recognized if the entity receives consideration from a customer and expects to refund some or all of that consideration to the customer. A refund liability is measured at the amount of consideration received (or receivable) for which the entity does not expect to be entitled (that is, amounts not included in the transaction price). The refund liability (and corresponding change in the transaction price and, therefore, the contract liability) should be updated at the end of each reporting period for changes in circumstances. 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 should recognize all of the following:

  1. Revenue for the transferred products in the amount of consideration to which the entity expects to be entitled (therefore, revenue would not be recognized for the products expected to be returned)
  2. A refund liability
  3. An asset (and corresponding adjustment to cost of sales) for its right to recover products from customers on settling the refund liability.

Following the guidance found in the Codification, George Risk does not recognize revenue for the products it expects to be returned by customers. Instead, George Risk recognizes these products as a refund liability. This account is then adjusted each period according to changes in circumstances.

 
Service Refund Liability at Despegar.com, Corp (Online Travel Booking)
 
   
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Although rights of return are most easily conceptualized for tangible goods, the same principles apply to refundable services. Despegar explained in its 2019 comment letter:

For refundable or cancellable transactions, the Company applies the guidance in ASC 606-10-32-10 and ASC 606-10-55-22 through 55-29. Therefore, the Company recognizes revenue when the traveler completes the booking and recognizes a refund liability against revenue until the refundable period expires. The refund provision is determined based on past objective historical experience. The Company reverses this provision for any unclaimed refund after the period the reservation becomes non-refundable which is usually after check-in date at which time the Company records revenue.

This example illustrates that the guidance on rights of return applies not only to physical goods but also to services with refund or cancellation provisions. Even though the service is performed at the time of booking, Despegar recognizes a refund liability for the portion of revenue that may be returned during the refundable period. This approach ensures that revenue reflects only the amount the entity expects to be entitled to after considering expected cancellations, consistent with the variable consideration guidance in ASC 606.

Presentation of Refund Liabilities and Refund Assets

While some may consider it reasonable to present refund liabilities and refund assets on a net basis, the standard indicates that these items should be presented separately. ASC 606-10-55-27 explains that the asset recognized for the right to recover products must be measured independently and presented separately from the related refund liability.

Although the standard does not explicitly address whether return assets must be presented separately from inventory, interpretive guidance from accounting firms consistently supports separate presentation on a gross basis (EY, Section 5.4; KPMG, Section 5.4.20). This view reflects the fact that the refund liability and return asset represent fundamentally different economic elements—one is an obligation to the customer, while the other is a right to recover goods. Netting these amounts would obscure both the entity’s exposure to refund obligations and the value of expected recoveries.

In addition, presenting the return asset separately from inventory enhances transparency and comparability, as the return asset is subject to unique measurement considerations (e.g., expected recovery costs and potential value reductions) and separate impairment evaluation. As a result, gross presentation—separating the refund liability, return asset, and inventory—is generally viewed as more decision-useful and consistent with the principles of ASC 606.

Example A: Right of Return

Vendor Y enters into a contract on December 1 with a customer to provide 100 widgets for a total consideration of $1,000. The terms of the contract, which are consistent with Vendor Y’s practices, allow for returns for any reason for up to 60 days for a full refund in either cash or store credit. Vendor Y has significant historical experience with customers of this type and expects an average of 3 percent of all widgets to be returned.

Analysis:

On the date of the sale, Vendor Y determines that it expects to be entitled to the full $970 for the 97 widgets not expected to be returned. Vendor Y determines that it is probable that no significant revenue reversal will occur for this amount. On this date, Vendor Y would make the following entries (assuming the carrying cost per widget is $5):

Rights of Return and Customer Acceptance in ASC 606 — illustration

Customer Acceptance Rights

Customer acceptance is one of the criteria for determining transfer of control in the revenue recognition process. If this criterion is not met, revenue recognition should be deferred. Determining whether customer acceptance exists requires careful analysis of the acceptance provisions or clauses within the contract.

Objective Criteria for Customer Acceptance

Customer acceptance rights may be based on objective criteria, such as size, weight, or specific performance metrics. If an entity can demonstrate that a delivered product meets the objective specifications in the contract, then control has effectively passed to the customer, and the entity should recognize revenue. In some instances, determining that objective customer acceptance rights have been met is a formality because the entity has sufficient experience with similar products being accepted according to the objective criteria in the contract. However, even without such history, an entity may still be able to objectively determine that control of a good or service has been transferred to the customer in accordance with the specifications in the contract (see ASC 606-10-55-86).

Non-Objective Criteria for Customer Acceptance

Conversely, if customer acceptance rights are based on non-objective criteria, then the entity is prevented from concluding that the customer has obtained control of the good or service. For contracts without objective criteria, entities typically defer revenue recognition until the customer formally accepts the product or service. In some cases, entities may allow a trial period for customers to determine whether they want to keep the product. If the customer is not obligated to pay consideration until the trial period expires, control does not transfer until the trial period lapses or the customer accepts the product.

 
Velo3D, Inc. SEC Correspondence
 
   
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Velo3D, Inc. is a leading provider of metal 3D printers. Along with manufacturing and distributing printers, it also provides printer analysis software, site installation, and consumer training in order to operate the printers correctly and effectively. Regarding customer acceptance and control of their product, Velo3D responded to the SEC in an August 2022 comment letter:

The Company advises the Staff that revenue related to the 3D Printer is recognized at a point in time, which occurs upon transfer of control to the customer at shipment. Site installation, testing and customer training are incidental to customer acceptance.

Velo3D determined that customer acceptance, either verbally or in writing, is merely a formality, or rather, it is clear the customer has accepted the printer if they have had it installed and tested, followed by training on how to operate the printer correctly.

 
Customer Acceptance Rights at Applied Materials, Inc. (Electronics Equipment, Services, And Software)
 
   
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Applied Materials, Inc., a manufacturer of semiconductor equipment and related services, addressed customer acceptance provisions in a February 2020 comment letter to the SEC. The company explained how it determines whether customer acceptance affects the timing of revenue recognition under ASC 606. It stated:

For goods or services delivered to a customer with agreed-upon specifications where the specifications have previously been delivered and accepted by the customer, or have been demonstrated based on repeatable data obtained from the customer and/or Applied [Materials]’ test labs, Applied typically considers the technical acceptance a formality that does not affect the determination of when the customer has obtained control of the good or service. Where Applied does not have prior experience of meeting agreed-upon specifications (for example, in cases of a new product with no history of meeting customer specifications), technical acceptance is considered a requirement before we conclude that the customer has obtained control, as described in ASC 606-10-55-87, and revenue is recognized. The majority of goods and services provided by Applied to its customers involve situations where Applied has prior experience of meeting agreed-upon specifications in a contract as described in ASC 606-10-55-86, and therefore Applied generally recognizes revenue upon delivery, rather than upon customer’s technical acceptance, of a good or service based on its experience with contracts for similar goods or services as outlined above.

This example highlights that customer acceptance provisions do not always delay revenue recognition. When an entity has sufficient experience demonstrating that its products consistently meet contractual specifications, customer acceptance may be considered a formality, and control may transfer upon delivery. However, when an entity lacks prior experience meeting the specifications—such as with a new product—customer acceptance may represent a substantive condition, and revenue should not be recognized until acceptance occurs.

In addition to the guidance discussed above, recent updates clarify the accounting for share-based consideration payable to customers. ASU 2025-04 further explains how equity instruments granted to customers affect the transaction price and are accounted for under Topic 718. While this update does not change the accounting for rights of return or customer acceptance, it clarifies related guidance affecting consideration payable to customers. See Noncash Consideration for more information.

Conclusion

Under ASC 606, rights of return are treated as variable consideration, so revenue should only be recognized for those goods not expected to be returned. A refund liability, presented separately from the associated refund asset, should be recognized for those goods expected to be returned. At the end of each reporting period, the refund liability should be updated to the amount for which it expects to be entitled in exchange for the goods. Corresponding changes should be made to the transaction price and the amount of revenue recognized in the transaction.

If all other revenue recognition criteria have been met for a contract with customer acceptance rights, an entity should recognize revenue when the customer signals acceptance of the goods or services, the acceptance period lapses, or the entity can objectively determine that the contract specifications have been met. Only in these circumstances can the entity conclude that control has been transferred to the customer.

Editor’s Note

The guidance discussed above continues to apply under current U.S. GAAP as of 2026, as no significant amendments affecting rights of return or customer acceptance have been issued since the adoption of ASC 606.

Resources Consulted

Footnotes
Brett Riley
Kathrine Jensen
May 16, 2020