[Anonymous]

On day 1, Clothes Co., sells clothing to Link Corp. for $40,000. Clothes ships the clothing on day 1 and Link is obligated to pay Clothes within six months. Links is given 12 months to return any of the clothing for a refund if they experience low demand. Link is also given 18 months to exchange any clothing due to low demand. At the time of sale, Clothes cannot reasonably estimate returns, but estimates $5,000 in exchanged goods. Clothes should recognize revenue for the aforementioned transaction

A. on the day of the sale

B. six months after the date of sale

C. 12 months after the date of sale

D. 18 months after the date of sale

Answer C

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What rule or topic is this question even testing?

[sdguy]

It's testing revenue recognition. It's not considered a sale unless you can reasonably estimate returns. GAAP aways follows conservatism.

AUD: 83
FAR: 77
REG: 86
BEC: 86

[Anonymous]

The question seems a bit vague. How do you get “At the time of sale” to be 12 months, since it doesn't specify when was time of sale?

[sdguy]

Determined – I don't think you're reading the question carefully, or maybe you're over-thinking it? Let's try to break it down:

1. It says a sale occurs (It doesn't matter when, call the sale date “x” if you want)

2. Customer is given 12 months to return any or all of the merchandise ( x + 12)

3. The seller can not reasonably estimate what percentage of the merchandise will be returned

4. Therefore, none of the sale can be recognized as revenue, until x + 12 time period (that is, after 12 months have passed, and the “net sale” (sales minus returns) can be determined.

Now if the situation were different, and they could reasonably estimate 10K in returns, then they could immediately recognize $30K revenue at time point “x” (date of sale), because $40K sales – 10K estimated return = $30K recognized revenue.

Does this make sense? It's actually a pretty straight forward question once you understand conservatism and revenue recognition principles.

AUD: 83
FAR: 77
REG: 86
BEC: 86

[Anonymous]

I see. I guess what was throwing me off was the 18 months to exchange clothes, since if they have to return the clothes in 12 months it kinda doesn't make sense that they have 18 months to exchange clothes, am I on the right track?

[EuroAddict]

I believe the 18 months doesn't come into play b/c it is an exchange. No money is going back to the customer. I believe we are to assume the exchange is for a product of equal value.

-----------------------------
BEC - 77, 03/2015 (first try)
FAR - 79, 05/2015 (second try)
REG - 83, 12/2015 (first try)
AUD - 84, 03/2015 (first try)

I got 99 problems but the CPA ain't one.

[sdguy]

As Euro said, ignore the exchange because it doesn't affect revenue at all.

AUD: 83
FAR: 77
REG: 86
BEC: 86

[Author]

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