Reserve for Returns
May 24, 2008
Book publishers sell books to stores and they return unsold texts for full credit. The rate of returns can exceed 30% of sales. Thus a sale is not really a sale.
Accounting standards (SFAS 48 and SFAS 5) state that estimated losses from contingencies (returns) shall be accrued against income, thus reducing income and accounts receivable.
All major publishers maintain a reserve for returns. For example:
John Wiley’s 1999 Annual Report:
Sales Returns and Doubtful Accounts: The Company provides an estimated allowance for doubtful accounts and for future returns on sales made during the year. The allowance for doubtful accounts and returns (estimated returns net of inventory and royalty costs) is shown as a reduction of receivables in the accompanying consolidated balance sheets and amounted to $41.8 and $41.6 million at April 30, 1999 and 1998, respectively.
How do you calculate the reserve?
Look at the rate of return on similar sales that you incurred in the past. Similar sales? For most book publishers this means calculating returns on sales to resellers and consumers separately. You make this two part calculation because resellers return more than consumers (15% to 40% vs. <1%).
Tax Implications & Software Tip
The IRS Code normally does not allow you to claim a deduction for expected future returns. Thus you pay taxes on income you may not receive.
There is one exception to this rule. Under Section 458 of the IRS code you can claim a deduction for paperback returns received in the first 4 1/2 months of the following year. Publishers intent on minimizing their tax liability should be careful to track sales & returns by binding: hardcover and paperback.
This provision is elective and “the election is made by filing a statement with the income tax return for the first taxable year for which the election is to apply.” - Accounting and Finance for Magazine (& Book) Publishers by Peter M. Craig
Software Tip: To take advantage of this deduction you should make sure that your software can track sales by binding - ie paperback.
