The Main Accounting Issue

The Main accounting issue
The main accounting issue in the case, is that Ernst & Young and its partners failed to exercise due diligence in evaluating the sales returns reserve on the financial statements of Medicis Pharmaceutical Company who violated the standards set by PCAOB. In other words, the company did failed to comply with return accounting standards, and bending the accounting rules resulted to inflated revenue. As such, the information provided to investors was not reliable since there was no audit evidence to back the company’s claim for reserving the sales at replacement cost. In recording the sales returns, the value of sales returns is deducted from the sales revenue as if the sales never occurred, through using the gross sales price unless the returns qualify for exceptions. There was a need to restate the financial statements to reflect the correction resulting from a review of revenue.
Basis for justifying use of replacement cost to estimate returns
Medicis required establishing a reserve for products returned by customers, but since this would affect the gross margin, the company relied on replacement cost and not the gross sales price. It was as though the products were replaced by other products. Medicis further argued that the returns were like ‘warranty replacement’, and E & Y went with this reasoning. Standard no. 48 does not oblige companies to use the gross sales price when setting reserve, but it is generally followed since reducing revenue because of the returns takes into account the gross price for the items. The company stated that an exception to SFAS 48 was applicable, despite the compan...