Trademark Inc.

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Case 03-05
Trademark, Inc.
Part 1—Accounting Issues
This case study is the first of a two-part Earnings Management Case. The purpose of Part
1 is to provide you with background information relating to Trademark, Inc. and raise several accounting and auditing issues affecting Trademark during the current fiscal year.
The conclusions reached in this case study will be used in Part 2 — Misstatements &
Trademark, Inc., a public company, designs, manufactures, and distributes greeting cards, calendars, stationery, party goods, and specialty gift merchandise. Trademark operates through four divisions: Greeting Cards and Stationery, Calendars, Party Goods, and
Specialty Gifts. In 1994, Trademark acquired a 100 percent
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The new boxes and packing materials appear to have substantially decreased the damage to Trademark’s products during the shipping process.
Warehouse management estimates that in fiscal year 1998, returns averaged 0.23 percent, and in fiscal year 1999, returns averaged 0.22 percent. The return rate in 1999 was lower than 1998 because the company was still in the process of using up its stock of old packaging materials in 1998. Warehouse management believes that damage levels will remain at the 0.22 percent level going forward.
Recognizing that the company may have over-accrued in fiscal year 1999 for future returns of damaged goods, Nancy requested audit evidence to support warehouse management’s claims that return rates had decreased. Based on the evidence examined,
Nancy concluded that the 0.22% return rate was accurate for fiscal year 1999 and appeared sustainable. To assess the reasonableness of management’s estimate for the reserve at June 30, 1999, Nancy developed an independent estimate of the reserve, factoring in the impact of the new packaging materials. Nancy developed a range of acceptable estimates and determined that management’s estimate was outside that range.
The difference between management’s estimate and the high-end of the range was
$923,077. This amount represents the estimated gross sales amount for the related returns. The average gross margin for the year was 65%.
Other Returns
In addition to returns of damaged
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