Question

A large company has hired your friend. She confides in you about a problem with her boss. Her boss has asked customers to sign sales agreements just before the end of the year, indicating a sale has been made. Her boss has told these customers that he will give them 30 days, which is Page 489 well into next year, to change their minds. If they do not change their minds, then he will send the merchandise to them. If they do change their minds, her boss has agreed to cancel the orders, take back the merchandise, and cancel the invoices. Her boss has given the sales agreements to the Accounting Department, which has prepared invoices and recorded the sales. One of the people in accounting is keeping the invoices and shipping documents for these customers in a desk drawer either until the customers change their minds, in which case the sale will be canceled, or until the merchandise is sent at the end of the 30-day waiting period. Questions 1. Does this sales policy violate ANY of GAAP's rules? 2. Does this sales policy violate any legal statutes at the state or Federal level? If so, relate them to the act under consideration in this case. If not, state why not.

Answer 1

1. Does this sales policy violate ANY of GAAP's rules?

Yes, it does violate GAAP rules. The agreement may valid considering it meets all the requirements of a valid contract. But the accounting department cannot recognize revenue from this contract since it doesn's meet the recognition rule. US GAAP in consultation with IFRS released a new standard for "revenue recognition". According to the new revenue recognition standard of US GAAP and IFRS, an accountant should follow the five-step model for recognizing revenue. One of the steps in revenue recognition not met in this contract. Following are the five steps for revenue recognition:-

1. Identify the contract with the customer - Met

2. Identify the performance obligation (to sell and pay money) - Met

3. Identify the transaction price - Met

4. Allocate the transaction price to different performance obligation- Met

5. Recognized revenue once the performance obligation satisfied - Not Met

In this case, the performance obligation not satisfied. The company can recognize revenue when they actually sell the merchandise. It's against the standard to recognize revenue before fulfilling performance obligation.

2. Does this sales policy violate any legal statutes at the state or Federal level?

It will not violate any legal statutes since the agreement meets all the requirements of a valid contract. From legal statutes, an agreement enforceable by law is a valid contract. An agreement is enforceable if it meets all requirements of a valid contract. This contract enforceable since it meets all requirements.