At the end of 2016, the accounting firm for which you work is auditing the books of Debitus Publishing Inc. for the first time. Debitus, a calendar year company, publishes textbooks that are used in colleges and universities across the country. These textbooks arc purchased by students through their campus bookstores. Debitus normally makes its biggest sales at the beginning of the fall semester. In the past, Debitus has always recorded sales returns in the spring semester when the campus bookstores return any unsold textbooks. This has been satisfactory, because the returns have been immaterial in amount.
In 2015, as a promotional strategy' to stimulate sales, Debitus began offering bookstores a reduced price if they ordered more textbooks. There is no penalty for returns of these textbooks if the bookstores cannot sell them to customers. This strategy worked; sales increased by 10% during 2015. In early 2016, however, a substantial amount of unsold textbooks were returned by bookstores to Debitus. Continuing the promotional strategy, sales increased by' 15% during 2016.
While reviewing the sales returns account for 2016, you notice that the only entry was for the textbooks returned earlier in the year. You note that these returns amounted to about 5% of the sales for the fall semester of 2015. Because this pattern of returns seems to you to be a trend that will continue, you raise the issue with the company controller as to whether all of the “sales” for the fall semester of 2016 arc actually revenue. The controller responds, “Of course they arc revenue; we sold the textbooks. Just because there will be some returns doesn’t mean we haven’t made sales. Besides, we don't know what percentage the returns will be. They might be as much as 5%, but definitely not more. Furthermore, we have already recorded all those returns at the beginning of 2016 that really applied to 2015. So we already have recorded our fair share of returns for 2016. As long as we record returns consistently, it will all work out. We don’t want a drop in earnings for 2016 because of a change in customer returns, our shareholders wouldn’t like that. Let’s just leave this issue alone."
Required:
From financial repenting and ethical perspectives, what do you think about Debitus’s policy in regard to sales returns?