FAS 48 and income statements for publicly held corporations
Auditing Tips by Donald BurlesonOctober 30, 2015
progress - incomplete
Oracle-centric auditing for FAS 48.
Oracle eBusiness Suite is one of the world's most
sophisticated Enterprise Resource Planning (ERP) packages, and it's important
for all Oracle Financials Functional experts to understand how generally
accepted accounting principles (GAAP) and the rulings of the financial
accounting standards board (FAS) are implemented within Oracle Financials.
Lets examine one of the most important areas of
financial accounting with Oracle Financials, the proper disclosure of income for
corporations who sell retail goods with rights of return.
Disclosure of expected returns
In todays marketplace, manufactures rarely sell
goods without rights to returns and hundreds of retail chains fill their stores
with "borrowed goods", products which may be returned for a full refund.
While the world of financial accounting is built
on hard numbers, accounting for unknown future events presents a unique
challenge. Financials accountants move away from hard number and enter the
world of forecasting which is governed by probabilities and uncertainly.
The central question addressed by FAS 48 is the
just and proper way to estimate an unknown
Within publicly held manufacturers and
distributors, a temptation exists to impress the investing community by
expressing an "optimistic" forecast of low returns.
Inside FAS 48
FAS No. 48, formally titled "Revenue Recognition When Right of Return
Exists", originally dated June 1981. While GAAP mandate that income be recorded
when it is received, FAS 48 outlines an important exception for publicly held
corporations who sells goods with full right of return. In a nutshell, FAS
48 states the conditions for reporting returns:
If an enterprise sells its product but gives
the buyer the right to return the product, revenue from the sales
transaction shall be recognized at time of sale only if all of the following
conditions are met:
a. The seller's price to the buyer is
substantially fixed or determinable at the date of sale.
b. The buyer has paid the seller, or the
buyer is obligated to pay the seller and the obligation is not contingent on
resale of the product.
c. The buyer's obligation to the seller would
not be changed in the event of theft or physical destruction or damage of
d. The buyer acquiring the product for resale
has economic substance apart from that provided by the seller.
e. The seller does not have significant
obligations for future performance to directly bring about resale of the
product by the buyer.
f. The amount of future returns
can be reasonably estimated
FASB 48 6(f) only remotely addresses the issue of
forecasting in a general sense and the term "reasonable" is the polestar and the
FAS directly thrusts the determination of "reasonable estimates" upon the
8. The ability to make a reasonable estimate
of the amount of future returns depends on many factors and circumstances
that will vary from one case to the next. However, the following factors may
impair the ability to make a reasonable estimate:
a. The susceptibility of the product to
significant external factors, such as technological obsolescence or changes
b. Relatively long periods in which a
particular product may be returned
c. Absence of historical experience with
similar types of sales of similar products, or inability to apply such
experience because of changing circumstances, for example, changes in the
selling enterprise's marketing policies or relationships with its customers
d. Absence of a large
volume of relatively homogeneous transactions
The existence of one or more of the above
factors, in light of the significance of other factors, may not be
sufficient to prevent making a reasonable estimate; likewise, other factors
may preclude a reasonable estimate.
As tax laws change, we see other pronouncements
that appear to apply to this case, such as SEC Staff Accounting Bulletins 101
and 104, not to mention prior cases, industry comparisons, and related
Ultimately, the tax courts decide the
interpretation of FAS 48, SAB 104 and current case law provides insights into
the responsibilities of corporation to accurately estimate returns.
Income is reported when it is received
All introductory accounting students are taught to
report income when it is received (realized, earned). This was codified by
SAB 101 (superseded by SAB 104 and later case law). This
Savient Pharmaceuticals notes the main tenet of reporting income as
SAB 104 states that revenue should not be recognized until it
is realized or realizable and earned. Revenue is realized or realizable and
earned when all of the following criteria are met:
(1) persuasive evidence of an arrangement exists;
(2) delivery has occurred or services have been rendered;
(3) the seller's price to the buyer is fixed and determinable; and
(4) collectability is reasonably assured.
Estimating future returns
We see further guidance in FAS 48 relating to the
entities ability to accurately estimate future returns based on historical
information. This is codified in FAS 5 "Accounting for Contingencies".