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Greetings Tutor, i hope you are doing well, can you please help me with the following
“The new finance director has informed the audit partner that since the year end there has been an increased number of sales returns and that in the month of May over $0.5 million of goods sold in April were returned”. (Audit Risk)
Audit Response “There have been a significant number of sales returns made subsequent to the year end. As these relate to pre-year-end sales, they should be removed from revenue in the draft financial statements and the inventory reinstated”.
I wanted to ask why are we adjusting sales return made in May to the sales related to reporting period? Shouldn’t sales return be treated as a Non-Adjusting Event as per IAS 10 and therefore providing a disclosure for the same as $0.5Million is likely to be a material amount?
Welcome to my AA forum! That’s a really interesting point you raise.
In practice, a standard audit test is to look at all credit notes raised after the year end, for whatever reason – goods returned, correction of overpricing, or just some amount of credit to the customer because they were not entirely happy with the goods (but didn’t return them). The journal entry for the sum of the credit notes would be: Dr Sales/Cr Receivables, adjusting the draft accounts, i.e. an adjusting event.
Here, the scenario tells you that credit notes are going to be raised after the year end in respect of goods returned. Disclosure is no substitute for adjustment. Image if the notes did effectively say “and by the way, $0.5m of sales didn’t really happen”, users would ask”what are they doing in the accounts then?”
The return of goods provides evidence that the customers aren’t going to pay for them – so there can be no receivable.
I hope that answers your question, but do ask if you need further clarification.
Thank you Tutor. I understood your point, but still its a bit difficult for me to digest that it would be an adjusting event especially based upon what i have studied under IAS 10 in past. Can you please elaborate a bit more on this 🙂
And also why the return is being directly adjusted to Sales, shouldn’t we record a Sales Return and show the same in Statement of Profit and Loss .
Regarding your second point – financial statements show a single line “Revenue” in SoPL – there may well be a separate “sales return” account in the general ledger, but these “non-sales” would have to be offset against sales recorded in the sales account.
If it wasn’t true that sales returns must be adjusted for, businesses could simply send out lots of goods to customers that they hadn’t ordered shortly before the year end, and so inflate sales. I’m sure you’d agree that that can’t be legitimate and would have to be “reversed”.
Of course I don’t know what you understand by adjusting/non-adjusting events based on past studies, but in a nutshell:
– Both are things that happen after the reporting date
– An adjusting event provides additional information/evidence about conditions that EXISTED at the reporting date
– Otherwise the event is non-adjustingSo at the reporting date, the draft FS show $0.5m receivables to exist – only the return of the goods after the y/e provides evidence that, with the “benefit of hindsight”, that they do not exist.
Also at the reporting date, the draft FS include inventory based on a physical count at the reporting date. That obviously excludes the goods that were sold in April. But with the benefit of hindsight, those goods were still the entity’s as they were returned to the entity – so the cost of these goods will be added to inventory.
What you are effectively doing is eliminating a profit that wasn’t realised in the reporting period.
Is that any better?
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