Of Platinum Trends Submitted By : Prateek Goyal Anshul Bansal Dinesh Jindal Prince Mandeep Manish Meena Summary Of The Case Platinum Trends which was established in 2003 , became a leader in Jewellery industry , Giving tough competition to national & international jewellers. With a number of Awards for excellence in design , innovation and branding , it has constantly moved ahead its peers. The company has a steady policy of billing its dealers on delivery of products and immediate revenue recognition. The company also allows its dealers to return any unsold product throughout the year and the sales returns are accounted for during the year.
The following table gives the companys sales and returns for years 2006,2007,2008 :
Year Sales Sales Net Sales Net Profit returns (in millions) 20X6 6412 1375 5037 2015
20X7 7907 1952 5955 2692
20X8 9109 2066 7043 3505 In June 2008, Sameer jain , an analyst questioned the companys accounting for sales returns and presented his report in an equity research paper as follows :
The company accounts for all actual returns but it does not account for returns that are probable as of the balance sheet date. What this means is that product sold in a year maybe returned in the following year. This would increase the revenue in the year of sale and reduce the revenue in the year of return. Industry trends suggest that sales returns exceed 20% therefore delay in recognition of returns could result in overstatement of revenue and allow the company to move its revenue from one period to another. In view of the above , we recommend SELL on Platinum trends shares. Platinum Trends issued following press release in response to sameer jains research report : The company recognizes revenue in accordance with 2 major conditions in the accounting standards -
A) The seller of goods has transferred to the buyer the significant risks and rewards of ownership of the goods and the seller retains no effective control of the goods transferred to a degree usually associated with ownership.
B) No significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods.
The Company explained that it has complied with both these conditions while there is some probability that the goods may be returned by the dealers, the amount of consideration is certain.
Once the company sells the products, the ownership passes to the dealers. Hence company has no control over the goods. Therefore it cannot record the return of such products.
The company accounts for returns from its dealers immediately and refunds the amount promptly, however accounting for expected returns as contrasted with actual returns , is fraught with risk. That kind of accounting would be based on estimation and not on facts. The company records its deep disappointment over the negative research report. Analyst's Comments The company accounts for all actual returns , it does not account for returns that are probable as of the balance sheet date. Products sold in a year may be returned in the following year, because they are no longer the flavour of the season. This would increase the revenue in the year of the sale but would decrease the revenue in the year of return. Companys delay in recognition of returns could result in overstatement of revenue and allow the company to move its revenue from one period to another. Companys Comments The company recognises revenue in accordance with the 2 major conditions in the accounting standards: 1. The seller of the goods has transferred to the buyer the significant risks and rewards of ownership of the goods and the seller retains no effective control of the goods transferred to a degree usually associated with ownership. 2. No significant uncertainty exists regarding the amount of consideration that will be derived from the sale of the goods. The company has complied with both these conditions. While there is some probability that the goods may be returned by our dealers, the amount of consideration is certain. Once the company sells the products the ownership passes to the dealer and company has no control over goods. Therefore, company cannot record return of such products. In our view, accounting for expected returns , as contrasted with actual returns, is fraught with risk. This kind of accounting would be based on estimation and not on facts. Our take on these comments According to us, the claims made by Altus Securities are true that Platinum Trends is not following accounting principles properly and this may lead to overvaluation of the company and many other flaws. The points given in response of these allegations by Platinum Trends are valid but the reason given for not accounting of expected returns is not justified at all. Also, According to the International Accounting Standard 18, we have a few points as mentioned on next page:
International Accounting Standard 18 Revenue If an entity retains only an insignificant risk of ownership, the transaction is a sale and revenue is recognised. For example, a seller may retain the legal title to the goods solely to protect the collectability of the amount due. In such a case, if the entity has transferred the significant risks and rewards of ownership, the transaction is a sale and revenue is recognised. Another example of an entity retaining only an insignificant risk of ownership may be a retail sale when a refund is offered if the customer is not satisfied. Revenue in such cases is recognised at the time of sale provided the seller can reliably estimate future returns and recognises a liability for returns based on previous experience and other relevant factors. As the sales returns generally exceeds 20% of sales , Platinum Trends can in no way neglect the sales returns in their accounting as it will have a huge impact on the revenue and other accounts. Hence a new policy needs to be formulated for Platinum Trends which may take into account the return sales too.
Accounting Policy For Revenue Recognition Including Sales Returns If an entity retains only an insignificant risk of ownership, the transaction is a sale and revenue is recognised. Revenue in such cases is recognised at the time of sale provided the seller can reliably estimate future returns and recognises a liability for returns based on previous experience and other relevant factors. 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:
Factors that 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 in demand. 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. We are given the data of the companys sales and returns for years 2006,2007,2008 :
Year Sales Sales Net Sales Net Profit returns (in millions) 20X6 6412 1375 5037 2015
20X7 7907 1952 5955 2692
20X8 9109 2066 7043 3505
We can clearly see from the data that the sales return in % terms of total sales is as follows:
Year Sales Returns(% of total sales) 20X6 21.44 20X7 24.68 20X8 22.68
As we see that the sales returns are continuously lying in the bracket of 20-25% ,the company should account for expected sales returns of an average of 22.5% each year and should place adjustment entries accordingly if the returns deviate from the expected value. Solution So there should be a new accounting policy in which Revenue is recognised at the time of sale and a liability for returns based on previous experience is recorded which in this given case comes out to be approximately 22.5 % of sales.