Revenue Cut-off on a Year-End Consignment Shipment
Rahman Textiles Ltd closes its books on 31 December. On 27 December, it shipped finished fabric with a list price of BDT 12,000,000 to a distributor under a sale-or-return arrangement. The distributor may return unsold goods within 90 days and historically returns about 15% of such consignments. Cost of the shipment was BDT 8,400,000. The sales manager booked the full BDT 12,000,000 as revenue on dispatch and recognised the entire margin, arguing the goods had physically left the warehouse and an invoice was issued. The credit controller notes the distributor has not yet confirmed acceptance and that a similar shipment last year was partially returned in February. The draft profit before tax is BDT 45,000,000; the audit materiality threshold is BDT 2,250,000. The CFO wants to know whether to adjust before the audit committee meets.
1. Evaluate whether the dispatch should be recognised as revenue at 31 December, applying the five-step revenue model. State the adjustment required and quantify its effect on profit before tax.
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Step 1 – Identify the contract. A signed distribution agreement exists, so a contract is present, but the sale-or-return clause means control may not have transferred.
Step 2 – Identify performance obligations. The single obligation is delivery of fabric with a right of return attached.
Step 3 – Determine the transaction price. The list price is BDT 12,000,000, but because returns are expected, the transaction price must be adjusted for expected returns. Using the 15% historical rate, expected returns are BDT 1,800,000, leaving expected consideration of BDT 10,200,000.
Step 4 – Allocate. Only one obligation, so no allocation issue arises.
Step 5 – Recognise when control transfers. Under a sale-or-return arrangement, revenue is recognised only to the extent that it is highly probable there will not be a significant reversal. The distributor has not confirmed acceptance and returns are expected, so recognising the full BDT 12,000,000 on dispatch is not supportable.
Adjustment. Reverse the full dispatch entry and recognise revenue of BDT 10,200,000 with a refund liability of BDT 1,800,000, and carry a right-to-recover asset of BDT 1,260,000 (15% of BDT 8,400,000 cost) with the corresponding reduction in cost of sales.
Quantified effect. Draft profit before tax of BDT 45,000,000 falls by the margin on the returned portion: revenue reduction of BDT 1,800,000 less cost reduction of BDT 1,260,000, i.e. BDT 540,000. The remaining BDT 540,000 is below the BDT 2,250,000 materiality threshold, but the qualitative issue (departing from the stated accounting policy and the risk of a full reversal) means it should still be corrected. If the auditor concludes control has not passed at all, the entire BDT 3,600,000 margin reverses, which is material and must be adjusted.
2. The sales manager argues that an invoice was issued and the goods left the warehouse, so revenue is earned. Rebut this argument and explain the audit evidence you would seek.
Read the worked answer
Rebutting the argument. Physical dispatch and the raising of an invoice are internal administrative acts; neither is the criterion for revenue recognition. The criterion is the transfer of control, i.e. the customer's ability to direct the use of, and obtain substantially all the remaining benefits from, the goods. A sale-or-return clause restricts the distributor's obligation to pay until resale or acceptance and gives it a right to return, so the customer has not assumed the significant risks of ownership. The invoice is therefore not evidence of a completed sale; it is evidence only that a dispatch occurred.
Audit evidence to obtain.
- The distribution agreement, to confirm the return window, acceptance terms and any price protection.
- The dispatch documentation and carrier receipt, to confirm the date and condition of goods.
- Correspondence with the distributor confirming whether acceptance has occurred before year-end.
- Historical return rates for comparable consignments, to test the 15% estimate.
- Post-year-end returns and credit notes, as subsequent-events evidence of the return rate and of whether control had passed.
- The entity's stated revenue policy, to test consistent application.
Conclusion. The evidence supports deferral or partial recognition, not full recognition on dispatch, and the post-year-end returns log is the strongest single test.