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What adjustments should be made for the special sale?

See attached file.

On the last day of the trading year the CFO arranged for a special $8.0m sale of video games to a long-time customer. This sale has been recorded in the normal way and is included in Sales Video Games and Accounts Receivable. The inventory has not been delivered and the 4m cost is included in Video Games inventory. The CFO has disclosed that this is a special deal, at current sales prices, but on a deferred settlement basis. Twenty five per cent of the total amount is due on 31 July 2010 with the balance due 3 years later. A contract has been drawn up and signed by both parties, but this does not provide for interest.

What adjustments, if any, should be made to the accounts in respect of this Special sale? Explain your decision stating clearly any assumptions you make. Should you record this sale on a present value basis?


Solution Preview

1. The first issue is whether this is a 'real' sale. Because the problem tells us there is a signed contract, that question is no longer an issue. A contractual obligation to pay is good enough for recording a sale.

2. Even though the inventory has not been delivered, it should be expensed for purposes of the financial statements. The gross margin is 8M - 4M of costs. Without this entry, inventory is overstated, cost of goods would be understated, and profits would be overstated. Secondly, ...

Solution Summary

The solution explains the effects of the sale, the corrections that must be made, and the concepts involved in the problem. There are five issues related to the transaction.