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Revenue Recognition: Do You Sell Inventory? If So, You're Going to Want to Read This!

“The new revenue recognition standard isn’t going to impact my company’s operations very much.” Does this phrase sound familiar?

As December 31, 2019 draws ever closer, it is apparent many companies are not prepared for the new revenue recognition standard issued under Accounting Standards Update (ASU) 2014-09, which established Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers. While the extent of the impact of ASC 606 will vary from company to company, if you sell and ship inventory, the standard will most definitely impact how you’re currently recording shipping and handling costs.

Many companies pay shipping and handling fees on inventory sold to a customer and include this additional cost as a component of their selling price to recoup the cost. Under 606, companies are going to need to determine if this form of shipping and handling activity will constitute a separate performance obligation requiring revenue recognition separately from the goods sold themselves.

To get to the right answer, companies will first need to determine if shipping and handling activities occur before or after customers have obtained control of the goods. In general, terms of the contract between a company and customer will ultimately determine when customers have obtained control of purchased goods. The two most common terms would be when control passes at the time of shipment (FOB Shipping Point) or when control passes when the product reaches the customers (FOB Destination). Depending on which terms accompany the sale, it will drive the resulting revenue recognition treatment.

In most cases, if the shipment occurs before the customer obtains control of the product (FOB Destination), then shipping and handling will not be considered a separate performance obligation, but rather a fulfillment activity. When considered a fulfillment activity, no separate revenue recognition for the shipping and handling is required. In circumstances where shipping occurs after a customer has received control of the goods (FOB Shipping Point), the shipping and handling services are generally considered a separate performance obligation.

So, what does all of this mean and how might it impact you and your business? When a separate performance obligation exists for shipping and handling, companies are required to allocate a portion of the selling price to that activity and separately recognize it as the company satisfies its obligation by delivering the product. In essence, a portion of your sale for goods with FOB Shipping Point would need to be deferred and recognized similar to FOB Destination, when the goods arrive to your customer and related performance obligation met. As one can imagine, this creates a cut-off and record-keeping nightmare.

Fear not, though, as there is a policy election available under ASC 606 that allows companies to bypass this potential record-keeping headache. Under ASC 606-10-25-18B, a company may elect an accounting policy whereby it may account for shipping and handling as fulfillment activities to fulfill the promise to transfer the product. Translation: the full amount of revenue may be recognized at shipment, as has always been done in the past, with no tracking of separate performance obligations. If your company elects to follow the accounting policy afforded under the accounting guidance, be sure to include such an election in the accounting policies in the footnotes of financial statements.

If you have questions, reach out to our team of experts today – we’re happy to assist in ensuring you have the appropriate disclosures and are properly prepared for ASC Topic 606.

This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.