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Recognizing Revenue When Right of Return Exists

Debbie Anaya David Phu Amanda Ramirez Patricia Santana. Recognizing Revenue When Right of Return Exists. Group 9. SAB 101 question 9. 3. The seller’s price to the buyer is Fixed or Determinable

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Recognizing Revenue When Right of Return Exists

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  1. Debbie Anaya David Phu Amanda Ramirez Patricia Santana Recognizing Revenue When Right of Return Exists Group 9

  2. SAB 101 question 9 3. The seller’s price to the buyer is Fixed or Determinable What "other factors," in addition to those listed in paragraph 8 of SFAS No. 48, has the staff identified that may preclude a registrant from making a reasonable and reliable estimate of product returns?

  3. Answer The following additional factors may affect the ability to make reasonable estimates of product returns: • Channel stuffing • Front loading: Lack or unable to determine the levels of inventory and the current level of sales to end users • New products may result in the technological obsolescence • Significance of a certain distributor to the registrant’s business, sales and marketing • The newness of a product • Introduction of competitors’ products with superior technology and changing trends in demand for the products

  4. SFAS No. 48Criteria for recognizing revenue when right of return exists Paragraph 6 • The seller’s price to the buyer is substantially fixed or determinable at the date of sale. • The buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product. • The buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product. • The buyer acquiring the product for resale has economic substance apart from that provided by the seller. • The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer. • The amount of future returns can be reasonably estimated.

  5. SFAS No. 48Criteria for recognizing revenue when right of return exists Paragraph 8 • The susceptibility of the product to significant external factors, such as technological obsolescence or changes in demand. • Relatively long periods in which a particular product may be returned. • Absence of historical experience with similar types of sales of similar products, or inability to apply such experience because of changing circumstances, for example, changes in the selling enterprise’s marketing policies or relationships with its customers. • Absence of a large volume of relatively homogenous transactions. *If a transaction fails to meet all of the conditions of paragraphs 6 and 8 in SFAS No. 48, no revenue may be recognized until the conditions have been met or the return privilege has expired, whichever occurs first.

  6. issue-type • Sales with a Right of Return at the point of sale

  7. Demo • Company ABC is a leading manufacturer of air compressors. The company released a new model of air compressors. • On January 1, 2014, Company ABC sells on account to Company XYZ 500 units at $500,000. Company ABC sells an 80% increase of units from previous years. ( Sales: $500,000/500 units = $1000 per unit) • Company XYZ has a right to return the product within 60 days of its purchase. • The manufacturing cost for Company ABC is $700 per unit. (COGS: $700 x 500 units = $350,000 ) Company ABC can not estimate a rate of return due to newness of the product. Prepare the journal entries to record the sale for Company ABC.

  8. Journal Entries January 1, 2014 Accounts Receivable $500,000 Unearned Revenue $500,000 Cost of Goods Sold (500 units x $700) $350,000 Inventory $350,000 March 2, 2014 Unearned Revenue $500,000 Revenue (500 units x $1000) $500,000

  9. Real world example Bristol-Myers Squibb is a leading global BioPharma company headquartered in New York City. The company develops, produces, and markets drugs or pharmaceutical licensed for use as medications.

  10. CHANNEL STUFFING • Bristol-Myers perpetrated a fraudulent earnings management scheme known as “channel stuffing”, among other things, selling excessive amounts of pharmaceutical products to its wholesalers ahead of demand, improperly recognizing revenue from $1.5 billion of such sales to its two largest wholesalers. • In addition , the company paid carry cost and guaranteed them a return on investment until they sold the products. • Channel Stuffing”: • Offering excess inventory to customers to create higher sales numbers.

  11. Channel stuffing • According to the SEC commission’s complaint, Bristol-Myers has agreed with out denying the allegations. • Due to the allegations and charges, the company distributed $750 million to shareholders affected by the fraudulent earnings management. • SAB 101: Additional factors may affect the ability to make reasonable estimates of product returns • Significant increases in or excess levels of inventory in a distribution channel

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