Question

You have noticed that the A/R clerk has created an abnormally high number of credit memos. You notice the inventory does not reflect the additional inventory resulting from the Sales Returns and Allowances. What could be happening, and what will you do?

Answer 1

When entity sells goods or service to its customers and allows it to pay later date i.e. after credit terms of say 30 days or 60 days, then this is called selling the goods on credit and creates current assets (Accounts receivables i.e. A/R) for the entity. When sale is made on credit then accounts receivables is documented through an invoice. Invoices are authorized by appropriate person of the entity. There should be procedure laid down in the entity that invoices should be prepared by another person and authorized by another. Further, recording of invoices should be done by account department following procedures and general accepted accounting principles. Internal control laid down in the entity should be rigorous so that no revenue gap should arise and recording of transactions should not left. All transactions must be authorized by proper person.

In the same way, when goods are returned by customer then credit memo should be issued by authorized person and accordingly recording of inventory and ledger of sales return as well as accounts receivables should be done.

There are some following cases from which accounts receivables are reduced and credit memo is issued:

1. Sales return (Impact on inventories: Increase)
2. Discount/Allowances & incentives (Impact on inventories: No impact)
3. Credit for defective goods/not satisfied services (Impact on inventories: No impact)
4. Bad debts (Impact on inventories: No impact)

In all above cases credit memo is issued by authorized person and proper accounting should be made.

Facts of the case: In this case clerk has created an abnormally high number of credit memos but inventory does not reflect the additional inventory resulting from sales return and allowances.

Audit trail of transactions: Source documents of sales, sales return or allowances must be checked and to ensure that transactions are authorized by appropriate person. In case of sales return, documents of goods inward at entry gate should be checked. Inventories should be recorded as follows:

                Inventory …. Dr.

                     To Cost of Goods sold

If company has given allowances/discounts then it must be authorized by higher management.

What will do?

After checking of audit trail of transactions, recording of inventory should be done in case of sales return. Either in case of allowance/discounts authorization from higher management should be taken to regularize the transactions.

Either if there is case of accounting fraud to manipulate the money receivables from accounts receivables then proper action should be taken.