Homework SourseAt December 31 2015 EarthWear has 5890000 in a liability acc
At December 31, 2015, EarthWear has $5,890,000 in a liability account labeled “Reserve for returns.” The footnotes to the financial statements contain the following policy: “At the time of sale, the company provides a reserve equal to the gross profit on projected merchandise returns, based on prior returns experience.” The entity has indicated that returns for sales that are six months old are negligible, and gross profit percentage for the year is 42.5 percent. The entity has also provided the following information on sales for the last six months of the year:
Required:
a. Using the information given, develop an expectation for the reserve for returns account. Because the rate of return varies based on the time that has passed since the date of sale, do not use an average historical return rate. (Enter all answers in dollars (not thousands of dollars). Enter Gross Margin value in decimals and not percentages, rounded to 3 decimal places. Omit the \"$\" sign in your response.)
EarthWear\'s income before taxes is $36 million (rounded). Assume that the auditors have decided that 5 percent of this benchmark is appropriate for planning materiality and allocate 50 percent of it as tolerable misstatement.
b. Determine a tolerable difference for your analytical procedure. (Omit the \"$\" sign in your response. Enter your answer in dollars not millions of dollars)
c. Compare your expectation to the book value and determine if it is greater than tolerable difference. (Omit the \"$\" sign in your response. Enter your answer in dollars not millions of dollars)
| Month | Monthly Sales (in 000s) | Historical Return Rate | ||
| July | $ | 73,300 | 0.004 | |
| August | 82,800 | 0.006 | ||
| September | 93,500 | 0.010 | ||
| October | 110,200 | 0.015 | ||
| November | 158,200 | 0.025 | ||
| December | 202,500 | 0.032 | ||
Solution
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| PART A | ||||
| Month | Sales | Return Rate | Return | |
| July | $ 73,300,000.00 | 0.004 | $ 293,200.00 | |
| August | $ 82,800,000.00 | 0.006 | $ 496,800.00 | |
| September | $ 93,500,000.00 | 0.01 | $ 935,000.00 | |
| October | $ 110,200,000.00 | 0.015 | $ 1,653,000.00 | |
| November | $ 158,200,000.00 | 0.025 | $ 3,955,000.00 | |
| December | $ 202,500,000.00 | 0.032 | $ 6,480,000.00 | |
| Total | $ 13,813,000.00 | |||
| Gross Margin | 42.50% | |||
| Auditors Expectation | 5870525 | |||
| PART B | ||||
| Considering 5% is the tolerable limit. Therefore tolerable | ||||
| difference would be 5% of reserve for returns. | ||||
| That is 5% of $ 5890000 = $ 294500 | ||||
| PART C | ||||
| Difference between book value and expectation is | ||||
| 5890000-5870525 = 19475 | ||||
