Refer to the Why It Matters feature "Risks Associated with Sales Returns: The Case of Medicis and Ernst & Young." What problems can occur if controls related to sales returns and allowances are not designed and operating effectively?

Check the explanation

Explanation:

In the case involving Medicis and Ernst & Young, Medicis utilized the value sales returns at replacement cost rather than gross sales price. Which resulted into:,

-. Sales return reserve was materially understated and -. Revenue was materially overstated

The significance of controls involving sales returns and valuation allowances: a) Sales returns represent an essential aspect of sales and profit / loss account. If the sales returns are not valued appropriately, income could be understated or overstated since sales are net of sales returns.

b) In the same way, if the returns on sales are not valued appropriately then accounts receivables could also be understated or overstated. Valuation of the allowance needed to be provided for the difference in valuation of sales and sales returns.

For this reason, appropriate controls ought to be kept in place for sales returns and also for their valuation and they should be operating effectively throughout the period.