Problem $2.$

Ulta is a specialty beauty retailer. It has physical stores, makes digital sales, and a loyalty program. The auditing firm, Ernst and Young, singled out the loyalty program as a critical matter in the course of the audit. This does not means they found anything wrong. It only means that the financial statements are sensitive to the method of accounting. In this case, the financial statements are sensitive to the estimates.

The auditing firm states this:

Loyalty Program

dscription of the The Company maintains a loyalty program, Ultamate Rewards, which offers members the ability to earn matter and redeem points on purchases of products and services. $[...]$

Auditing the Company's estimate of loyalty deferred revenue was complex as the calculation involved management's assumptions, such as the standalone selling price and expected redemption rate, which drive the revenue deferral. In particular, the estimate is sensitive to these significant assumptions, which are affected by expectations about future customer behavior.

How we addressed the matter in our audit

We obtained an understanding, evaluated the design, and tested the operating effectiveness of the Company's estimation process and controls supporting the measurement and recognition of the amount of loyalty revenue deferred. This included testing controls over management's review of the assumptions and other inputs used in the estimation, the completeness and accuracy of issuance and redemption data used in the calculation, and controls over the assignment of membership levels based on customer spending patterns.

Our audit procedures included, among others, evaluating the methodology used, analyzing the significant assumptions discussed above, and testing the accuracy and completeness of the underlying data used in management's calculation. To test the standalone selling price per point, we validated that the price per point for each membership level was appropriate based on products or services purchased by loyalty members. To audit the redemption rate, we tested redemption activity and compared the results of that testing to the redemption rate used by management in its estimate. In addition, we tested the value of points redeemed was complete and accurate. We also considered recent trends in redemption activity and the impact on the redemption rate. In addition, we performed sensitivity analyses of significant assumptions to evaluate the change in the deferral amounts.

Ulta has this to say about the loyalty program:

Loyalty program

The Company maintains a loyalty program, Ultamate Rewards, which allows members to earn points based on purchases of merchandise or services. Points earned are valid for at least one year. The loyalty program represents a material right to the customer and points may be redeemed on future products and services. Revenue from the loyalty program is recognized when the members redeem points or points expire. The Company defers revenue related to points earned that have not yet been redeemed. The amount of deferred revenue includes estimates for the standalone selling price of points earned by members and the percentage of points expected to be redeemed. The expected redemption percentage is based on historical redemption patterns and considers current information or trends. The standalone selling price of points earned and the estimated redemption rate is evaluated each reporting period. When a guest redeems points or the points expire, the Company recognizes revenue in net sales on the consolidated statements of income.

Ulta has multiple obligations when a customer of Ulta makes a purchase. Suppose Ulta makes sales of $$100,000$ for the week on goods that cost $$45,000.$ Of the $$100,000,$ management estimates the standalone selling price of the points as $$10,000.$

By the end of the period, $$6,000$ of the points have been redeemed for $$3,500$ of merchandise. The other $$4,000$ of the points expire.

Required

Provide the journal entries for

a$.$ The customers' purchase, the sales revenue, and the deferred revenue. Also, provide the entry for the cost of goods sold for the purchase.

b$.$ The redemption of the points. Also, provide the entry for the cost of goods sold for the redemption.

c$.$ The expiration of the remaining points.

If you were the auditor and your task was "testing controls over management's review of the assumptions and other inputs used in the estimation," what would you do$?$ Describe the controls. Include a description of why management's possible override of controls is important to be aware of$.$ For example, in the givens above, suppose the customers' purchase of $$100,000$ is on December $31.$ What is the effect of estimating the standalone price higher than the given