[DocJ]

Lew Co. sold 200,000 boxes for $2 each. Lew’s cost was $1 per unit.

It was determined, with appropriate reason, that 5% of the boxes would be returned. Lew absorbed an additional $10,000 to process the returns and expects to resell the boxes.

What amount should Lew report as operating profit from this transaction?

$170,000
$179,500
$180,000
$200,000

Answer:
$400,000 – 200,000 units sold x $2 per
– 20,000 – Returns (200,000 units x 5% x $2)
$380,000 – Net Sales

$200,000 – COGS (200,000 units at $1 per)
– 10,000 – Provision for returns (10,000 × $1)
$190,000 – Net COGS

$190,000 – Gross profit ($380K – $190K)
– 10,000 – Return processing cost
$180,000 – Operating Profit

…..Wait, that can’t be right? You got $400,000 from selling the boxes and $200,000 COGS, so $200,000 net profit before returns, right?

Then 10,000 boxes were returned, which means you give customers back their $2, totaling $20,000 in returns. Then there’s another $10,000 in processing costs, so basically $30,000 in your paying for returns.

$200,000 net profit – $30,000 returns and processing = $170,000 net profit.

AND you expect to re-sell those boxes, again for $2, so 10,000 boxes at $2 means $20,000 regained.

$170,000 + $20,000 = $190,000 grand total net profit.

How’s it $180K? o_O

[turo9992000]

I don't think you are considering the return correctly. You are picking up the 10,000 processing cost, but you are not considering the provision for return. If they are planning on selling the returned merchandise again then the journal entry would be to debit inventory 10k and credit COGS 10k. If COGS is credited 10K then your 170K operating profit would increase to 180K.

[AusNat]

You wouldn't accrue for the anticipated re-sales until they actually happen. Consider that distractor info. Conservatism – they need to accrue the estimated returns and associated costs, but you don't record revenue until the re-sale is made.

Also, don't forget that both sales AND cost of goods sold will be reduced for the returns. So expected net profit is
400,000 gross sales
Less: 200,000 cost of goods sold
Less: 20,000 estimated 5% sales returns
Plus: 10,000 cost of goods for 5% estimated returns (this is going back into inventory)
Less: 10,000 estimated return processing & repackaging fees
= 180,000

[Shark]

200,000 Boxes
Less: 10,000 Returned Boxes (5% of 200,000)
Equals: 190,000 Boxes
Then: 190,000 times $2 (price)
Revenue Equals: $380,000
Less: 190,000 times $1 (cost)
COGS Equals: $190,000
Then: Revenue – COGS
Equals: $380,000 – $190,000
Gross Profit Equals: $190,000
Then: Gross Profit – Absorption
Equals: $190,000 – $10,000
Operating Profit Equals: $180,000

[bigstakk]

The way AusNat explains it is the easiest way to understand the answer. It’s actually a straight forward problem when you exclude the additional resale info that is not applicable since it hasn’t happened yet. It’s just distractor info which is part of the trick to FAR and each of the exams.

[tysonjustis]

sales return journal entries:

dr. sales return and allowance $xxx <— contra revenue account
cr. cash/A/R $xxx

dr. inventory $xxx
cr. COGS $xxx <— reversing COGS expense

[DocJ]

“Also, don't forget that both sales AND cost of goods sold will be reduced for the returns.”

This is probably what tripped me up. We reduce COGS with returns? I was always under the impression that COGS is irreversible 😮

[Author]

Replies