I. What are two major controls for sales returns and allowances transactions? Wh
ID: 2577226 • Letter: I
Question
I. What are two major controls for sales returns and allowances transactions? What are the control objectives for each?
II. For each of the following situations based on SAB No. 101, indicate the audit evidence that should be obtained to determine whether revenue should be recognized or not in the current period:
The company you are auditing, Thomson Telecom, maintains an inventory of telecommunications equipment. Bayone Telephone Company placed an order for 10 new transformers valued at $5 million, and Thomson delivered them just prior to December 31. Thomson's normal business practice for this class of customer is to enter into a written sales agreement that requires the signatures of all the authorized representatives of Thomson and its customer before the contract is binding. However, Bayone has not signed the sales agreement because it is awaiting the requisite approval by the legal department. Bayone's purchasing department has orally agreed to the contract, and the purchasing manager has assured you that the contract will be approved the first week of next year.
Best Products is a retailer of appliances that offers “layaway” sales to its customers twice a year. Best retains the merchandise, sets it aside in its inventory, and collects a cash deposit from the customer. The customer signs an installment note at the time the initial deposit is received, but no payments are due until 30 days after delivery.
Dave's Discount Stores is a discount retailer who generates revenue from the sale of membership fees it charges customers to shop at its stores. The membership arrangement requires the customer to pay the entire membership fee (usually $48) at the beginning of the arrangement. However, the customer can unilaterally cancel the membership arrangement and receive a refund of the unused portion. Based on past experiences, Dave's estimates that 35 percent of the customers will cancel their memberships before the end of the contract.
Explanation / Answer
According to SAB 101, revenue should not be recognized until it is realized or realizable and earned. The transactions must feel the following criteria before revenue is recognized:-
1. There is persuasive evidence of arrangement.
2. Delivery has occurred or services have been rendered.
3. The seller's price to the buyer is fixed or determinable.
4. Collectability is reasonably assured.
So, in the above case we find that:-
1. There is persuasive evidence of arrangement:-
It is the practice of Thomson Telecom to enter into a written sales agreement that requires the signatures of all the authorized representatives of Thomson and its customer before the contract is binding. But since the requisite approval has not received by the legal department, Bayonne has not signed the sales agreement therefore, Bayonet’s purchasing department has orally agreed to the contract. So in my view this oral agreement can't be persuasive since it is the practice of Thomson Telecom to enter into a written sales agreement, therefore revenue can't be recognized.
2. Delivery has occurred or services have been rendered.
Thomson delivered the 10 new transformers valued at $5 million just prior to December 31 therefore revenue can be recognized.
3. The seller's price to the buyer is fixed or determinable.
“Valued at $5 million “- revenue can be recognized.
4. Collectability is reasonably assured.
The purchasing manager has assured that the contract will be approved the first week of next year - revenue can be recognized.
We find that out of the four conditions, one condition is not satisfied therefore, revenue should not be recognized.
This is the case of "layaway Sales". Let us understand the meaning of layaway sales first.
Under layaway sales generally retailers offer layaway sales arrangements to their customers, where customers are allowed to set aside specific items for customers, usually in exchange for a layaway deposit. In this particular case, retailer retains custody of the goods until the customer pays the remaining balance on the goods.
Accounting under Layaway Sales: - The seller only recognizes revenue when it delivers the goods. However, if the seller’s historical experience shows that most lay away transactions are converted into sales, and then it can recognize revenue when it receives a significant deposit, provided that the goods are on hand, identified and ready for delivery.
In the case of Best Products, Best will retains the merchandise and set aside such product from its inventory. Also best collects a cash deposit from the customer, Therefore the accounting for such deposit will be consider as Current liability for Best. Since they owe the deposit amount.
Journal Entry shall be passed in this case:-
Cash Account shall increase with the amount of cash deposit and Current liability account we may also call as layaway liabilities account shall also be increase with the amount of deposit.
Cash Debit (xxxx)
Layaway liabilities account Credit (xxxx)
Since no right on goods transfer to the customer, Therefore only the deposit received shall be account for in the books of accounts of Best Products.
Yes they can recognize the revenue at the time when the membership is arranged for customers. The amount should be The total revenue minus the 35% of the customers cancellation fees.