Terms of Reference
This report is to assess the appropriateness of the accounting methods Saskatoon store used and whether the accounting methods used by the Saskatoon store were fair in the context of the contest. Because Shmevan has 75 stores in the chain, it is important to use a recognized standard as the basis for preparing the statement. Accordingly, I recommend using GAAP. While GAAP are not necessarily the best criteria to settle the unsolved issues, GAAP are widely known and recognized. And basically all recommendations made in this report are supportable in terms of GAAP, fairness, and accrual accounting.
The objective in preparing this report is to come up with reasonable and justified assessments for the controversial accounting issues that Saskatoon store has in its measurement of net income in year 2004 and 2005.
The issues to deal with in this report are: the revenue recognition method, inventory valuation method, inventory write off, commercials cost, advance commission payment in 2004, gain from sales of capital assets.
Revenue recognition: There are two revenue recognition issues that must be addressed: the critical event approach to recognize revenue in general, the critical event approach to recognize revenue for promotion sales
1. The critical event approach to recognize revenue in general
The Saskatoon store normally recognizes revenue when goods are delivered to customers. Delivery of goods is most common applied critical events in critical event approach to recognize revenue. At this point, the customers have owned the goods and most efforts required by Saskatoon store has been completed. Most costs are known at this time. Collection from the customers is still an open question. Consider Saskatoon store is not new in the business, we can reasonable assure that the amount will be collected. This alternative meets the four criteria and in generally it is reasonable.
2. The critical event approach to recognize revenue for promotion sales
The Saskatoon store ran a promotion in Sep and Oct 2005 that offered significant discounts to customers who make large purchases and allowed the customers return any purchases after 90 days for a full refund for any reason. Alternatives points for recognize this revenue include:
a. When goods are delivered to customers
b. When services have been fully delivered to customers (when the right-of–return period expired )
Although discount sale is normal strategy to promote sales and increase income, from the evidence that sales in Sep and Oct 2005 were significantly higher than in the same months of the previous year and sales in November 2005 declined from 2004 we doubt that Saskatoon store’s method to boost the sales:
First, from the evidence it is obviously increase the short-term sales but since the business supplies needs are relatively stable, this method will hurt the future sales (that why November sales decline).
Second Saskatoon allows its customers to return any purchases after 90 days for a full refund for any reason. Therefore after the goods were delivered to the customers, there are uncertainties costs that may be incurred. For example, the customers who made large purchases with discounted price in September or October may find some of the purchased merchandises are not necessary and will return to the store. This kind of return goods is a significant cost for the store.
So although method a is justified in general situation, in this case the store should make an estimating amount of allowance for the returns and recognize the amount as expense in 2005. Because under GAAP matching, expense is reported in the same period as revenue that the expense helped to earn. If the management cannot make the estimation of the allowance, it would be appropriate to defer revenue recognition until after the right-of-return period has expired.
For the store used the delivery critical event approach to recognize the revenue of the September and October discount sales in 2005 fiscal year, the possible costs of the return were ignored and the income of September and October was overstated. Therefore, this recognition method is unjustified.