At the end of 2007, the accounting firm for which you work is auditing the books of Debitus Publishing Inc. for the first time. Debitus, a calendar year company, publishes textbooks that are used in colleges and universities across the country. These textbooks are purchased by students through their campus bookstores. Debitus normally makes its biggest sales at the beginning of the fall semester. In the past, Debitus has always recorded sales returns in the spring semester when the campus bookstores return any unsold textbooks. This has been satisfactory because the returns have been immaterial in amount. In 2006, as a promotional strategy to stimulate sales, Debitus began offering bookstores a reduced price if they ordered more textbooks. There is no penalty for returns of these textbooks if the bookstores cannot sell them to customers. This strategy worked; sales increased by 10% during 2006. In early 2007, however, a substantial amount of unsold textbooks were returned by bookstores to Debitus. Continuing the promotional strategy, sales increased by 15% during 2007. While reviewing the sales returns account for 2007, you notice that the only entry was for the textbooks returned earlier in the year. You note that these returns amounted to about 5% of the sales for the fall semester of 2006. Since this pattern of returns seems to you to be a trend that will continue, you raise the issue with the company controller as to whether all of the “sales” for the fall semester of 2007 are actually revenue. The controller responds, “Of course they are revenue; we sold the textbooks. Just because there will be some returns doesn’t mean we haven’t made sales. Besides, we don’t know what percentage the returns will be; they might be as much as 5 percent, but definitely not more. Furthermore, we have already recorded all those returns at the beginning of 2007 that really applied to 2006. So we already have recorded our fair share of returns for 2007. As long as we record returns consistently, it will all work out. We don’t want a drop in earnings for 2007 because of a change in customer returns; our shareholders wouldn’t like that. Let’s just leave this issue alone.”

Required
From financial reporting and ethical perspectives, what do you think about Debitus Publishing Inc.’s policy in regard to sales returns?