Chapter 7, Problem 7.4BYP

Real World Case 7–4

Sales returns; Green Mountain Coffee Roasters

• LO7–4

Real World Financials

The following is an excerpt from Sam Antar, “Is Green Mountain Coffee Roasters Shuffling the Beans to Beat Earnings Expectations?” (Phil’s Stock World delivered by Newstex, May 9, 2011.)

On May 3, 2011, Green Mountain Coffee Roasters (NASDAQ: GMCR) beat analysts’ earnings estimates by $0.10 per share for the thirteen-week period ended March 26, 2011. The next day, the stock price had risen to $11.91 per share to close at $75.98 per share, a staggering 18.5% increase over the previous day’s closing stock price. CNBC Senior Stocks Commentator Herb Greenberg raised questions about the quality of Green Mountain Coffees earnings because its provision for sales returns dropped $22 million in the thirteen-week period. He wanted to know if there was a certain adjustment to reserves (“a reversal”) that helped Green Mountain Coffee beat analysts’ earnings estimates. . . .

During the thirteen-week period ended March 26, 2011, it was calculated that Green Mountain Coffee had a negative $22.259 million provision for sales returns. In its latest 10-Q report, Green Mountain Coffee disclosed that its provision for sales returns was $5.262 million for the twenty-six week period ending March 26, 2011, but the company did not disclose amounts for the thirteen-week period ended March 26, 2011. In its previous 10-Q report for the thirteen-week period ended December 25, 2010, Green Mountain Coffee disclosed that its provision for sales returns was $27.521 million. Therefore, the provision for sales returns for the thirteen-week period ended March 26, 2011 was a negative $22.259 million ($5.262 million minus $27.521 million).

Required:

1. Access EDGAR on the Internet. The web address is www.sec.gov.

2. Search for Green Mountain Coffee Roasters, Inc.’s 10-K for the fiscal year ended September 25, 2010 (filed December 9, 2010). (Note: the company now is named Keurig Green Mountain, Inc.) Answer the following questions related to the company’s 2010 accounting for sales returns:

a. What type of an account (for example, asset, contraliability) is Sales Returns Reserve? Explain.

b. Prepare a T-account for fiscal 2010’s sales returns reserve. Include entries for the beginning and ending balance, acquisitions, amounts charged to cost and expense, and deductions.

c. Prepare journal entries for amounts charged to cost and expense and for deductions. Provide a brief explanation of what each of those journal entries represents.

d. For any of the amounts included in your journal entries that appear in Green Mountain’s statement of cash flows on page F-8, explain why the amount appears as an increase or decrease to cash flows.

3. Now consider the information provided by Antar in the excerpt at the beginning of this case.

a. Prepare a T-account for the first quarter of fiscal 2011’s sales returns reserve. Assume amounts associated with acquisitions and deductions are zero, such that the only entry affecting the account during the first quarter of fiscal 2011 is to record amounts charged or recovered from cost and expense. Compute the ending balance of the account.

b. Prepare a T-account for the second quarter of fiscal 2011’s sales returns reserve. Assume amounts associated with acquisitions and deductions are zero, such that the only entry affecting the account during the first quarter of fiscal 2011 is to record amounts charged or recovered from cost and expense. Compute the ending balance of the account.

c. Assume that actual returns were zero during the second quarter of fiscal 2011. Prepare a journal entry to record amounts charged or recovered from cost and expense during the second quarter of fiscal 2011. How would that journal entry affect 2011 net income?

d. Speculate as to what might have caused the activity in Green Mountain’s sales returns account during the second quarter of fiscal 2011. Consider how this result could occur unintentionally, or why it might occur intentionally as a way to manage earnings.

To determine

(2)(a)

Sales return:

The goods or the products which are sent back by the buyer to the seller are referred as sales return. It is a contra revenue account which reduces the sales revenue indirectly by debiting it.

To explain: Sales return reserve is which type of an account.

Explanation of Solution

Sales returns reserve is a contra asset account. It reduces the book value of accounts receivable account to the extent of the estimated sales returns for the period. As the accounts receivable is a current asset, the sales returns reserve serves as contra asset account. In this case, GMC Company is using reserve instead of allowance, and this reserve serves the same purpose like the allowance method does.

To determine

To prepare: A T-account for fiscal year 2010’s sales returns reserve of GMC Company.

Explanation of Solution

Following is the T account of the sales returns reserve of GMC Company for the fiscal year 2010:

 Sales Returns Reserve (in million dollar)

Deductions	31,237		Beginning balance		3,809
			Acquisition		31
			Cost and expense charged		40,139
			End balance		12,742

Conclusion

Thus, T-account for fiscal year 2010’s sales returns reserve of GMC Company is prepared as above.

To determine

To prepare: Journal entries for amount charged to cost and expense and for the deductions.

Explanation of Solution

Following are the journal entries for the amounts charged to cost and expense and for the deductions:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Sales returns		40,139
	Sales returns reserve			40,139
	(Being the amount of estimated sales returns charged to cost and expense)

Table (1)

• Sales returns reduces the sales revenue and sales revenue is a component of stockholders’ equity and it is considered as amount charged to cost and expense, therefore debit sales returns account for $40,139.
• Sales returns reserve account is a contra asset account and it reduces the accounts receivable account, therefore credit sales returns reserve account for $40,139.

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Sales returns reserve		31,237
	Accounts receivable			31,237
	(Being the actual sales returns affecting both sales returns reserve account and accounts receivable account)

Table (2)

• Sales returns reserve is reduced by actual sales return and therefore it reduces the stockholders’ equity, hence debit sales returns reserve account for $31,237.
• Accounts receivable account is an asset and it is reduced by the actual sales return, therefore credit accounts receivable account for $31,237.

To determine

To explain: The reason that why the amount appears as an increase or decrease to cash flow.

Explanation of Solution

To find out cash flow from the operating activities, $40,139 is added back to the net income of the GMC company, because the sales returns of the same amount reduces the sales revenue and the net income, even though it is not a virtual use of the cash. The reduction of $31,237 in the accounts receivable on account of the actual sales returns in included in the overall change in receivable account ($102,297) for the fiscal year.

To determine

To prepare: A T-account for the first quarter of fiscal year 2011’s sales returns reserve of GMC Company and compute the ending balance of the account.

Explanation of Solution

Following is the T account of the sales returns reserve of GMC Company for the fiscal year 2011:

Sales Returns Reserve (in million dollar)

Deductions	0		Beginning balance		12,742
			Cost and expense charged		27,521
			End balance		40,263

Conclusion

Thus, T-account for fiscal year 2011’s sales returns reserve of GMC Company is prepared as above and the ending balance of the account is $40,263.

To determine

To prepare: A T-account for the second quarter of fiscal year 2011’s sales returns reserve of GMC Company and compute the ending balance of the account.

Explanation of Solution

Following is the T account of the sales returns reserve of GMC Company for the fiscal year 2011:

 Sales Returns Reserve (in million dollar)

Recovery from A	22,259		Beginning balance		40,263
Deductions	0
			End balance		18,004

Conclusion

Thus, T-account for fiscal year 2011’s sales returns reserve of GMC Company is prepared as above and the ending balance of the account is $18,004.

To determine

To prepare: The Journal entries to record the amount charged or recovered from the cost and expense during the second quarter of fiscal 2011.

Explanation of Solution

Following are the journal entries for the amounts charged or recovered from the cost and expense during the second quarter of fiscal 2011:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Sales returns reserve		22,259
	Recovery of sales returns			22,259
	(Being the amount of estimated sales returns charged to cost and expense)

Table (3)

• Sales returns reserve is reduced by actual sales return and therefore it reduces the stockholders’ equity, hence debit sales returns reserve account for $22,259.
• Recovery of sales returns increase the revenue account, hence credit recovery of sales returns by $22,259.

To determine

The reason for the activity caused in GMC Company’s sales return account during the second quarter of fiscal 2011 and explain whether it could occur intentionally or unintentionally.

Explanation of Solution

• The company could have been experienced lower than expected returns by overestimating returns in Q1 by a very large amount unintentionally. Then in order to reduce the allowance it had correct their estimate amount.
• On the other hand, the company in order to shift income from Q1 to Q2, it could have intentionally overestimated returns in Q1. This is because income would be reduced by the estimated returns in Q1 and the income would be increased by the recovery in Q2