June 2003

Accounting Changes for Sales Incentives Cause Restatements

By Joel Steinberg

FASB’s Emerging Issues Task Force (EITF) recently addressed several issues involving the display of revenue in financial statements. FASB addressed these issues because many companies are valued, at least in part, by their revenue. The EITF’s concern grew from the recent practice by some companies of attempting to raise their market capitalization by artificially inflating gross revenue.

The consensus reached by the EITF has caused some companies to make significant downward revisions to previously reported revenues, with corresponding reductions in costs and expenses. EITF 01-9, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products), codifies the issues previously addressed in EITF 00-14, Accounting for Certain Sales Incentives; 00-22, Accounting for “Points” and Certain Other Time-Based or Volume-Based Sales Incentive Offers, and Offers for Free Products or Services to Be Delivered in the Future; and 00-25, Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor’s Products. The consensus addressed whether the cost of sales incentives should be reported as an expense or as a reduction in revenue. The consensus became effective for annual or interim periods beginning after December 15, 2001.

Types of Sales Incentives

Payments and incentives given by a manufacturer (or vendor) to a retailer (or reseller) are common in certain industries. Slotting fees, buydowns, and cooperative advertising are common incentives. Slotting fees are consideration given to a retailer to obtain space on the retailer’s shelves or in the retailer’s catalog, and payments for brand development or new-product introduction. In a buydown program, a vendor reimburses or issues credit memos to a retailer for decreased revenue during a promotion period. Related forms of consideration include factory incentives, dealer holdbacks, price protection, and factory-to-dealer incentives. Cooperative advertising programs provide for vendor participation in the cost of a reseller’s advertising. The amount reimbursed to the reseller typically is limited to a specified percentage of purchases from the vendor.

Sales incentives are also provided by vendors to indirect customers. For example, manufacturers provide discounts, coupons, rebates, and free products or services to the consumer or end user, rather than the retailer.

Classification. When a company sells a product or service and also provides consideration to the customer, how should the cost of the consideration be classified? Has the company effectively adjusted the sales price, and therefore earned less revenue, or has the company incurred a cost in making the sale?

The answer depends upon whether the consideration is in the form of cash or in the form of a free product or service. Cash consideration includes not only actual cash payments to the customer, but also incentives that reduce the customer’s present or future payment obligation. For example, credits against future purchases are a cash consideration. Examples of free products or services include gift certificates or free airline tickets that will be honored by another, unrelated entity.

Cash Consideration

The EITF reached a consensus that cash consideration given by a vendor to a customer constitutes by presumption a reduction of the selling price of the vendor’s products or services and, therefore, should be characterized as a reduction of revenue. The presumption is that the consideration cannot be separated from the revenue transaction. That presumption can be overcome if two conditions are met: separability and measurability.

Cash consideration can be separated from the revenue transaction if the vendor receives an identifiable benefit in exchange for the consideration. The identified benefit must be sufficiently separable from the customer’s purchase of the vendor’s products that the vendor could have acquired the benefit from someone other than the customer. Slotting fees, product placement fees, and fees to obtain an exclusive supply contract would not meet this condition, because the vendor does not receive a benefit that can be separated from the sale of the vendor’s product. Cooperative advertising, on the other hand, could meet this criterion because the vendor could have purchased the advertising from someone other than the customer, and the vendor obtains a benefit that can be separated from the sale to this particular customer.

Measurability requires that the fair value of the benefit received by the vendor can be reasonably estimated. Cooperative advertising and other payments for advertising often meet this condition because the vendor may be able to determine what the advertising would have cost if obtained from another party.

If the above conditions are met, the consideration would be classified as an expense rather than as a reduction to revenue. The amount classified as an expense, however, would be limited to the fair value of the benefit received by the vendor. If the consideration paid by the vendor exceeds the fair value of the benefit received, the excess would be classified as a reduction to revenue.

Consideration Involving Deliverables

If the consideration provided by the vendor consists of the delivery of a free product or service, rather than cash, then the cost of the consideration should be characterized as an expense, and not as a reduction of revenue. This distinction is predicated on the vendor actually delivering something to the customer, rather than just rebating a portion of the sales price. Accordingly, the cost of the deliverable is characterized as an expense to the vendor.

Determining whether an incentive consists of cash consideration or a deliverable can depend upon the form of the arrangement. Consider the case of a manufacturer that sells goods to a retailer and agrees to provide the retailer with custom fixtures to display the product. If the retailer pays to have the fixtures installed and receives a cash payment or an allowance from the manufacturer, this would be characterized as cash consideration and would accordingly be classified as a reduction in revenue in the manufacturer’s financial statements. If, however, the manufacturer installs the fixtures, the manufacturer is providing a deliverable, and, accordingly, the cost would be classified as an expense.

Impact of the New Rules

Upon the adoption of EITF 01-9, companies are required to restate all prior comparative periods presented. A search of recently filed 10-Q Forms found several major corporations that restated previously reported revenue and expenses as a result of the adoption. Some of these companies are presented in the Exhibit. The restated figures are for the first quarter of 2001.

Other EITF Consensuses Impacting Revenue Display

The EITF has also reached other consensuses regarding the display of revenue in financial statements. The adoption of these consensuses can also require a company to revise previously reported revenue and expenses:

Joel Steinberg, CPA, is a managing director at American Express Tax & Business Services Inc.

Robert H. Colson, PhD, CPA
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