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Accounting for payments and discounts to customers

Many companies sell to large, national retailers. Often, when selling to these retailers, these companies will need to make separate payments to these customers or have amounts deducted from the payments received on their invoices. However, many times we don’t see these accounted for appropriately. How should these be accounted for? It depends on the nature of each.

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Payments made to these retailers can be for such items as:

  • Cooperative advertising – This is where your company and the retailer share the costs for locally placed advertising of your company’s products.
  • Product placement or promotion – An example of this is “slotting”, where you pay an amount to the retailer to place your product in a desirable location at the retailer that will gain customers’ attention
  • Rebates – An example of this where you pay your customer an amount based upon a percentage of purchases from you.

Often, we see companies that recognize these amounts in cost of sales, or as an operating expense, since the company is often making a payment directly to the customer. Under the new revenue standard, you should determine whether you are receiving a distinct good or service from the customer. If you are and the fair value of the distinct good or service can be determined, then the fair value would be recognized as an expense of the company and any excess between the amount of consideration to the customer over the fair value would be recognized as a reduction of recorded revenue. For example, you pay a customer $20,000 for certain advertising in local newspapers and television but you determine that the fair value of the advertising services is $15,000.  In this case, $15,000 would be accounted for within your expenses and the excess $5,000 would be reflected as reduction of your revenue. If you cannot reasonably estimate the fair value of the goods or services received in return, you would reduce revenue by the entire amount paid to the customer.

Deductions from payments received on your customers’ invoices can be for such items as:

  • Early pay discounts – This is where the retailer takes a discount on payment when they pay within a certain number of days (for example, 10 days from receipt of the goods).
  • Returns allowance – This is where a retailer short-pays each invoice by a certain percentage to account for expected customer returns.
  • Chargebacks – This occurs when a retailer short-pays an invoice for charges such as damaged shipping boxes, late delivery, or when required information is missing within shipping documents.

Early pay discounts and returns allowance should be estimated upon the sale to the customer, which will reduce the revenue that is recognized since it reduces the amount of consideration you expect to receive from the transaction. These amounts should not be recognized within cost of sales or as an operating expense. Chargebacks are usually difficult to predict since it is the retailer that is making that determination. If that is the case, excluding any other discounts, you would expect to collect the full amount of the invoice. Accordingly, any estimate for chargebacks would not be considered when recognizing revenue.

 

Jonathan Poppel, CPA