Question

During the course of wrapping up the 2017 audit of your firm’s client, Best Appliances, Inc., you discover the following sales activity that occurred in late December 2017.  Best Appliances has recorded sales for 275,000 appliances for the month of December.  This amount is similar to the prior year’s December sales.  The revenue for December sales activity was booked at year end even though payment had not yet been received.

Best Appliances, an accrual basis entity, manufactures major appliances for sale to major retail stores and home repair chains.  Best Appliances sells these appliances to nine different retail stores and home repair store chains.  These sales contain a 120 day right of return.  Best Appliances has never received any appliances back since it started operations in 1977.  In addition to the right of return clause, Best Appliances has guaranteed to undertake an extensive $15,000,000 national advertising campaign to promote the high quality and dependability of the major appliances it sells to retail stores and home repair chains.  Your audit manager has requested information from you regarding appropriateness of the booking of the revenue related to December sales.

Prepare a 1-1 ½  page memo to the file for your audit manager.  Don’t forget to cite your authority (FASB Codification cites) for your conclusions.

Answer 1

The booking of revenue is different in case of sales made with a 'right of return' clause as compared to normal sales. In this case, there is a change in the possession of goods, however, the ownership is transferred only on the approval by the buyer of such goods. Therefore, it is advisable to maintain a separate set of books like sale or return day book and sale or return ledger. Goods which are sent to the buyer on sale on approval or return basis are recorded in sale or return day book. Afterwards, the accounts of the individual buyers are separately debited in sale or return ledger whereas the sale or return account is credited with the total of sale or return day book. Goods that are accepted by the buyer and in respect of which no intimation has been received within the specified time frame are considered as sales and accordingly recorded under sales day book. The accounts of the buyers are individually debited whereas the sales account is credited with the sales day book. Earlier entries need to be cancelled by crediting individual accounts and debiting sales or return account. At the year end, the credit balance in the sales or return account in sales or return ledger indicates such goods which are awaiting approval. They should be treated as inventories and properly accounted for in the regular books of accounts.

Considering the above, it can be said that the treatment done by the company is not appropriate.