This memo’s purpose is to address PCAOB’s order against Ernst & Young and their partners delivered on February 8, 2012. The main issue in the order was how E&Y failed to properly evaluate Medicis Pharmaceutical Corporations’ (Or Medicis Company’s) method on estimating sales returns and allowances. According to the PCAOB order, Medicis was allowing their customers (whom were mainly wholesale distributors) to return expired or nearly expired products. Medicis was reporting allowances for sales returns based on replacement cost rather than sale price, which resulted in their revenues being materially overstated. The order sites SFAS 48 (also consistent with ASC 605-15-25) which provides guidance criteria for sales transactions with rights to return. PCAOB concluded that the transactions in the scope of this issue have met all the necessary criteria from Paragraph 6 of SFAS 48 (for the sake of space Paragraph 6 was omitted from this memo). The requirement for measurement recognition for returns is cited in paragraph which 7 states:
7. If sales revenue is recognized because the conditions of paragraph 6 are met, any costs or losses that may be expected in connection with any returns shall be accrued in accordance with FASB Statement No. 5, Accounting for Contingencies. Sales revenue and cost of sales reported in the income statement shall be reduced to reflect estimated returns.
Regardless of Medcis’s departure from GAAP, E&Y issued an unqualified opinion, which resulted in action from the PCAOB.

Exception Rule
Medicis and E&Y initially justified the use of replacement cost for their sales returns allowances based on SFAS 48, Footnote 3 which states:
--Exchanges by ultimate customers of one item for another of the same kind, quality, and price (for example, one color or size for another) are not considered returns for purposes of this Statement.