In a sale with a right of return, how should the estimated return be treated?

The treatment of estimated returns in a sale with a right of return is rooted in the revenue recognition principle. When a company sells a product that may be returned, it must recognize the risk that some portion of the sales will be reversed through returns.

Recognizing the estimated return as a reduction in sales revenue accurately reflects the anticipated decrease in revenue resulting from future returns. By estimating the returns and adjusting the sales revenue accordingly, the financial statements present a more accurate picture of the company's revenue earned from sales during the accounting period. This approach aligns with the principle of conservatism in accounting, where accountants prefer to report figures that avoid overstating revenues.

In contrast, alternative treatments—such as recording the estimate as an asset or liability or ignoring the returns until they occur—would not adequately reflect the potential impact of returns on overall revenue and could mislead stakeholders regarding the company’s performance. The practice of recognizing estimated returns ensures that both revenues and expenses (related to the potential return of goods) are matched properly in the financial statements.