Question

At December 31, 2015, EarthWear has $5,890,000 in a liability account labeled “Reserve for returns.” The footnotes to the financial statements contain the following policy: “At the time of sale, the company provides a reserve equal to the gross profit on projected merchandise returns, based on prior returns experience.” The entity has indicated that returns for sales that are six months old are negligible, and gross profit percentage for the year is 42.5 percent. The entity has also provided the following information on sales for the last six months of the year:

Month	Monthly Sales (in 000s)		Historical Return Rate
July	$	73,300	0.004
August		82,800	0.006
September		93,500	0.010
October		110,200	0.015
November		158,200	0.025
December		202,500	0.032

Required:

a. Using the information given, develop an expectation for the reserve for returns account. Because the rate of return varies based on the time that has passed since the date of sale, do not use an average historical return rate. (Enter all answers in dollars (not thousands of dollars). Enter Gross Margin value in decimals and not percentages, rounded to 3 decimal places. Omit the "$" sign in your response.)

Months	Estimated Returns
July	$
August
September
October
November
December
	$
Gross Margin	×
Auditor expectation	$

     

EarthWear's income before taxes is $36 million (rounded). Assume that the auditors have decided that 5 percent of this benchmark is appropriate for planning materiality and allocate 50 percent of it as tolerable misstatement.

b. Determine a tolerable difference for your analytical procedure. (Omit the "$" sign in your response. Enter your answer in dollars not millions of dollars)

Tolerable difference

$

c. Compare your expectation to the book value and determine if it is greater than tolerable difference. (Omit the "$" sign in your response. Enter your answer in dollars not millions of dollars)

Difference between book value and expectation is (Click to select)less thangreater than tolerable difference of

$

Answer 1

PART A
Month	Sales	Return Rate	Return
July	$   73,300,000.00	0.004	$       293,200.00
August	$   82,800,000.00	0.006	$       496,800.00
September	$   93,500,000.00	0.01	$       935,000.00
October	$ 110,200,000.00	0.015	$   1,653,000.00
November	$ 158,200,000.00	0.025	$   3,955,000.00
December	$ 202,500,000.00	0.032	$   6,480,000.00
		Total	$ 13,813,000.00
		Gross Margin	42.50%
		Auditors Expectation	5870525
PART B
Considering 5% is the tolerable limit. Therefore tolerable
difference would be 5% of reserve for returns.
That is 5% of $ 5890000 = $ 294500
PART C
Difference between book value and expectation is
5890000-5870525 = 19475

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