Trademark Incorporated designs, manufactures, and distributes gift merchandise. Trademark manufactures its goods in five plants across the United States and operates through four divisions: Greeting Cards and Stationery, Calendars, Party Goods, and Specialty Gifts. In addition, Trademark also owns a Swiss company that manufactures similar products in Western Europe. The Swiss company operates as a separate, wholly-owned subsidiary. Trademark began operating in 1981 and offered their stock to the public in 1992.
1- Are revenue and cost of sales understated by not applying the correct percentage of right of return for damaged goods?
2- For other returns, if there is no legal right to return the merchandise nor the ability to make a reasonable estimate, should the company recognize the revenue or defer it?
Analysis for Issue 1 - Return of Damaged Goods
Regulation ASC, Rule 605-15-25-1 states:
If an entity sells its product but gives the buyer the right to return that product, revenue from the sales transaction shall be recognized at time of sale only if all of the following conditions are met:
a. The seller 's price to the buyer is substantially fixed or determinable at the date of sale.
b. The buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product. If the buyer does not pay at time of sale and the buyer 's obligation to pay is contractually or implicitly excused until the buyer resells the product, then this condition is not met.
c. The buyer 's obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product.
d. The buyer acquiring the product for resale has economic substance apart from that provided by the seller. This condition relates primarily to buyers that exist on paper, that
References: Financial Accounting Standards Board. ASC 605-15-25-1: Revenue recognition- Products-Recognition- Paragraph 1. Financial Accounting Standards Board. ASC 605-15-45-1: Revenue recognition- Products-Other Presentation matters- Paragraph 1. Financial Accounting Standards Board. ASC 980-605-35-1: Regulated Operations- Revenue Recognition-Subsequent Measurement- Paragraph 1. Financial Accounting Standards Board. ASC 605-15-15-1: Revenue recognition- Products-Scope and Scope Exceptions- Paragraph 1. Financial Accounting Standards Board. ASC 450-20-25-2: Contingencies- Loss Contingencies-Recognition- Paragraph 2. Financial Accounting Standards Board. ASC 605-50-25-9: Revenue Recognition- Customer Payments and Incentives-recognition- Paragraph 9. Financial Accounting Standards Board. ASC 605-50-25-4: Revenue Recognition- Customer Payments and Incentives-recognition- Paragraph 4. Financial Accounting Standards Board. ASC 605-10-S99: Revenue recognition- Overall-SEC Materials.