Question from: College Accounting, 15th, Price, Haddock and Farina, McGraw-Hill

Question

Question from: College Accounting, 15th, Price, Haddock and Farina, McGraw-Hill Companies

Chapter 7 Problem 1ED (Ethical Dilemma on page 238)

You are the bookkeeper of a retail store. Credit memos are created when a product is returned. A debit to Sales Returns and Allowances and a credit to Accounts Receivable (A/R) is recorded when a credit memo is created. A credit memo will reduce A/R and write off the invoice. You have noticed that the A/R clerk has created an abnormally high number of credit memos. You notice the inventory does not reflect the additional inventory resulting from the Sales Returns and Allowances. What could be happening, and what will you do?

Explanation / Answer

The key is to notice exceptions and oddities, such as transactions that are: at odd times of the day, month, season; too many or too few; in the wrong branch location; in amounts too high, too low, too consistent, too different. Exceptions and oddities like these can appear:

1.If caused by Item invoices, Check the linked income account for tracking sales.

2. If it is A/R account, need to change this account to an income account. Transactions like these have debited and credited AR when the sale is recorded. Not only is AR understated, but booking no income.

3. When these erroneous sales are paid by the customer, the payment of the invoice will reduce the AR balance even further, with a Debit to cash or undeposited funds, and a Credit to A/R.

5. If it has been doing this for a long time, the A/R balance could be a very large negative number. Adjust it with a journal entry. Debit A/R to bring it to where it should be, and credit the sales income account. Break up the income (sales) allocation to several income accounts, representing the various income accounts that should have been used on the Service or Item sales.

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