New accounting standards adopted by the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) require changes in revenue recognition for retail and distribution companies. Previously, we covered the five steps for revenue recognition that every company must now take.
If you are a company operating in a retail and/or distribution capacity, the following summary will give you an overview of what to do to be in compliance with the required changes. If your firm has not done so already, now is the time to review current accounting practices for your organization, so that they can be modified as necessary to become in compliance with the new rules, which go into effect for public companies on December 15, 2017, and December 15, 2018, for private companies.
New Accounting Rules for Retailers/Distributors
The general guidance includes recognizing revenue in such a way that accounts for the timing of the transfer of contractually promised goods and/or services to customers and using the proper amounts that reflect the value of the consideration that an organization receives for providing those goods and/or services. Consideration can be cash payments, bartered items, contract obligations, or anything valuable that is given in exchange for receiving the goods and/or services.
As we noted before, these general guidance rules require taking the five following steps:
Step 1 – Identify all contracts with a particular customer.
Step 2 – Review the performance obligations for each party under the contract.
Step 3 – Calculate the transaction value.
Step 4 – Allocate the transaction value according to the timing required for the performance obligation(s) under the contract.
Step 5 – Recognize revenue at the time of the satisfaction of the performance obligation(s).
Retail/distribution companies now need to use good judgment for the following situations:
- Making estimates for the amount and timing of any goods that will be returned.
- Accounting properly for the value of granting any optional future benefits to customers, such as offering discounts to customers for future purchases of products and/or services.
- Accounting for any consideration that is payable in the future to customers, such as the value of reward points accumulated, but not yet redeemed, in customer loyalty programs.
- Accounting for any consideration that is actually paid to customers, such as redemption of rewards points, use of discount coupons, and/or the use by customers of instant rebate coupons.
- Accounting for accumulated charges and payments made under a reseller and/or distributor contract.
- Accounting for contractual payments of licensing and/or franchise fees.
- The accounting treatment of warranties remains essentially the same as before.
A Revenue Recognition Example for Customer Options
Here is an illustrative example to demonstrate the accounting methods used for a customer option, which now has different revenue recognition procedures under the new rules.
If a customer, as part of a sale, also receives an option to acquire goods and/or services at some point in the future, there are two performance obligations to account for. The first is the sale itself and the second is the value of the optional benefits that a customer may choose to receive, which must be accounted for as a separate performance obligation. Options may take the form of sales incentives such as discount coupons, vouchers for free services, and contract fee waivers for renewals.
When an option is a separate performance obligation, part of the consideration (money, bartered services, contract obligations etc.) paid for the transaction needs to be allocated towards the value of the option. If the option is not exercised by the customer, then this is considered “breakage” and an accounting entry is made when the option expires without being used, to account for any value that the company expects to receive from the failure of a customer to exercise an option.
Even though this is just one example, it helps illustrate the necessary steps for analysis of revenue recognition as an overall concept.
There are a variety of situations commonly experienced by retail/distribution companies that fall under the new rules, which now require new accounting methodologies. Revenue recognition allocation procedures need to be put in place to handle these situations consistently and in accordance with the new rules. It is best to contact the experts at Palazzo Inc. for a complete assessment of your current situation and for recommendations about accounting procedures before you experience any difficulty for failing to be in compliance with these new rules.
Here are resources (downloadable pdf files) that we recommend reviewing in order to learn more about this subject:
- Revenue Recognition Standards For Retail and Consumer Businesses (IRFS 15)
- Revenue Recognition – Multiple Element Arrangements (revised September 2016)
- Retail & Distribution Spotlight – Revenue Recognition Restyled
- New Revenue Standard Issued
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Contact us to find out if you qualify for a valuable, no-obligation Discovery Consultation to further explore implementing these new standards and to validate the new accounting procedures are being applied correctly at your company.