Assignment 5 Essay

500 Words2 Pages
Background Medicis sells pharmaceutical products to wholesale distributors and retail drug chains and gives customers a right to return products that are expired or nearly expired. Most of the company’s products have a shelf life of 18 to 24 months. The right of return does not require customers to purchase replacement products, although most often returned products are replaced with fresh ones during the same quarter that Medicis issues return credits. The main accounting issue is that the company’s auditors, E&Y, failed to comply with PCAOB auditing standards in evaluating Medicis’s sales returns reserve estimate, evaluating Medicis’s reserving for most of its estimated product returns at replacement cost, rather than gross sales price, resulted in Medicis’s reported sales returns reserve being materially understated and its reported revenue being misstated. Analysis of Issue On what basis did Medicis initially justify the use of replacement cost to estimate returns? Why is it valid or invalid? Medicis justified the use of replacement to estimate returns using ASC 605-15-15-2 (Revenue Recognition - Products – Scope and Scope Exceptions) which states including: 15-2 (a). [E]xchanges by ultimate customers of one item for another of the same kind, quality, and price (for example, one color or size for another) are not considered returns for purposes of this Subtopic. E&Y reasoned this as it creates an exception to the general rule of reserving for expected future product returns at the gross sales price and deferring the recognition of an equal amount of revenue. This justification is invalid. The company’s customers are not “ultimate customers,” but are wholesalers that sold their product to retailers. In addition, Medicis’s returns were not returns of products in exchange for products of “the same kind, quality, and price,” but of unsalable product for

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