Question

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 ASC606, indicate the audit evidence that should be obtained to determine whether revenue should be recognized or not in the current period:

1. The company you are auditing, Morgan Telecom, maintains an inventory of telecommunications equipment. Peaks Telephone Company placed an order for 10 new transformers valued at $5 million, and Morgan delivered them just prior to December 3 Morgan'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 Morgan and its customer before the contract is binding. However, Peaks has not signed the sales agreement because it is awaiting the requisite approval by the legal department. Peaks' 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.
2. Good Products is a retailer of appliances that offers “layaway” sales to its customers twice a year. Good 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.
3. Taylor'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, Taylor's estimates that 35 percent of the customers will cancel their memberships before the end of the contract.

Answer 1

Sales Return and Allowances :

Sales return and allowances are the 2 different types of transactions, however they recorded in the same account. Sales return arises when a customer returns damaged, defective, undesirable products. However, Allowances arises when customer agrees to keep the product in return for a deduction in the sales price.

Major Control :

1. Each credit memo should be sanctioned by another individual, this is known as separation of duties.

2. The credit for a returned product should be backed by proper documentation indicating that the goods have actually been returned.

As per ASC 606, Revenue recognition principle, the revenue should be recognised only and only when the following conditions are being satisfied:

1. Identification of the customer

2. Satisfaction of the Performance obligation in the contract

3. The transaction price

Case-1

In the given case, the auditor should ask for the following audit evidences :

Contract between Morgan Telecom and Peak Telephone company, he must check entries in the general ledger, invoices and supporting documents and then ascertain that whether the revenue should be recognised or not as per ASC 606. The revenue should not be recognised, sincePeak Telephone company has not sign the contract and is consequently not a party to the contract

Case-2

In the given case, Good Products shall recognise the Revenue as per ASC 606 since all the conditions are being fulfilled. It does not matter that the payment will be received after 30 days, since there is no such condition in the standard for the same.

Case-3

In the given case, Taylor's Discount store should not recognise 100% revenue since there is uncertainty for the 35% portion. However, they should recognise the balance 65% in the books of accounts and the auditor should document the reason from the management for 35% uncertainty