Unexpected woe of the E-commerce Industry

Unexpected woe of the E-commerce Industry

What do you think is the biggest cause of misery for the E-commerce industry?

It isn’t Data Security, it isn’t Customer Loyalty, nor is it Competition. It is actually the Logistics surrounding cost of Sales Returns!

You will be shocked to know that the rate of Sales return in the E-commerce industry falls in the bracket of 30-35%! Yes, you read those numbers right. This implies that out of 100 products bought on Amazon or Flipkart each day, around 35 are returned by the customers! Talk about impulsive shopping! I bet this is also making you think twice before placing that return order!

Have you wondered how big players like Amazon and Flipkart account for these sales returns?

When a return order is placed, the company incurs double the cost for logistics. The previous IGAAP provided no clarity on how to account for these sales return costs, which resulted in inconsistent in attaining the objectives of financial reporting in the industry.

The introduction of IND AS and International Financial Reporting Standards has provided specific guidelines on this matter. Let us understand with the help of a case-study:

E-Mart, a leading player in the E-commerce industry sells 10,000 N-95 masks in a year. The Cost of production is INR 30 per mask and the Selling price is INR 50 per mask.

Assuming that the average sales return percentage in the industry is 30%, E-Mart expects that out of 10,000 masks sold, 3000 are bound to be returned (10,000*30%).

International Financial Reporting Standard 15 and IND AS 115 says that Sales with a Right of Return should be accounted as below:

1. Revenue for the transferred products:

Recognized at the net amount of revenue (consideration) the entity expects to receive after the product returns have been considered into the sale.

2. A Refund Liability:

• A refund liability includes the expected number of returns that the entity anticipated – for which the entity does not expect to receive any consideration/revenue.
• The refund liability shall be updated at the end of each reporting period for any changes in estimation. The adjustments shall be recognized as revenue (or reductions of revenue).

3. An asset (and corresponding adjustment to cost of sales):

• The entity might have a right to recover products from customers who demand a refund – this is effectively a reduction in the cost of goods sold. Thus, it shall be recognised as entity’s right to recover products on settling a refund liability.

• At the end of each reporting period, the estimation of future returns shall be updated & the measurement of recovery asset and refund liability shall also be revised – this might result in revision of revenue recognised.

Therefore, upon transfer of control of the 10,000 masks, E-Mart will not recognize the revenue for the 3000 products that it expects to be returned.

Considering all these details, this is how E-Mart will record the above transaction as follows:

1. Total Revenue:

For 7000 masks [10,000*(1-30%)] at INR 50 per mask = INR 350,000

2. Total Cost:

For 7000 masks at INR 30 per mask = INR 210,000

3. Total Liability:

To be created for expected returns of 3000 masks [10,000*30%] at INR 50 per mask = INR 150,000

4. Total Assets:

Create a corresponding asset for its right to recover products from the customers on settling the refund liability on the 3000 masks that are expected to be returned at INR 30 per mask = INR 90,000

The return asset will be presented and assessed for impairment separately from the refund liability. E-Mart will need to assess the return asset for impairment and adjust the value of the asset if it is impaired.

Thus, the net business exposure for the sales return transaction at the time of immediate transfer of control of the masks is INR 60,000 (150,000-90,000).

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