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Appropriate Accounting Treatment for price protection and price protection

To Susan Madigan
24th of Jan, 2013
Re: Appropriate Accounting Treatment for price protection and price protection _____________________________________________________________________________________________

The revenue recognition principle states that, under the accrual basis of accounting, you should only record revenue when an entity has substantially completed a revenue generation process; thus, you record revenue when it has been earned. Sales return is the return of merchandise by a customer. In accordance with generally accepted accounting principles, when a buyer has a right to return a product in the future in accordance with formal or informal agreement, a seller may or may not be able to recognize revenue at the time of sale. In these cases, recognizing returns and allowances only as they occur could cause profit to be overstated in the period of the sale and understated in the return period. To avoid misstating the financial statements, sales revenue and accounts receivable should be reduced by the amount of returns in the period of sale if the amount of returns is anticipated to be material. We must account for all returns, including those that occur in the period of sale and those that are estimated to occur in future periods. The returns that occur in the period of sale are easy to account for, but the returns estimated for future periods are more difficult. We reduce sales revenue and accounts receivable for estimated returns by debiting a sales returns account (which is a contra account to sales revenue) and crediting an “allowance for sales returns” account (which is a contra account to accounts receivable). When returns actually occur in a following reporting period, the allowance for sales returns is debited and accounts receivable is credited. In this way, income is not reduced in the return period but in the period of the sales revenue.

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