Income statement classification of certain sales incentives

By Dan Sandstrom, CPA
Accounting & Auditing Standards Committee

Much attention has been given to various issues involving revenue recognition ever since the debut of Staff Accounting Bulletin 101, Revenue Recognition in Financial Statements, as issued by the U.S. Securities and Exchange Commission (SEC) in June of last year.

Many of the follow-on issues raised have been dealt with by the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB). In particular, two issues recently addressed by the EITF that have potentially significant effects on manufacturers and distributors (i.e., vendors) involve the accounting for certain sales incentives, including rebates, coupons, slotting fees, buydowns and cooperative advertising, to name a few. The subject of this article is limited to the classification of those incentives. (Issues of recognition and measurement are beyond the scope of this article).

The two issues addressed, and for which a consensus was reached, are:

the accounting for certain sales incentives such as rebates, coupons and free products or services;
the accounting for consideration from a vendor to a retailer (or wholesaler) in connection with the purchase or promotion of a vendor's products.

The basic premise under the first issue is that a reduction in, or refund of, the selling price of a product or service resulting from a sales incentive shall be characterized as a reduction of revenue in the vendor's income statement. Alternatively, if the incentive takes the form of providing a free product or service (e.g., providing a free "toaster"), then the cost of such incentive should be classified as an expense. (The SEC Observer noted that this expense should be included in cost of goods sold for vendors that are subject to the rules and regulations of the SEC.)

The basic premise under the second issue is that to the extent consideration is paid by the vendor to a retailer (or wholesaler), such is considered an adjustment to the sales price and characterized as a reduction of revenue, unless the following criteria are met:

The vendor receives an identifiable benefit in return for the consideration.
The vendor can reasonably estimate the fair value of such benefit.

With respect to the second issue, in order to meet the first criteria, the benefit must be sufficiently separable from the retailer's purchase of a vendor's product such that the vendor could have entered into an exchange transaction with another party to receive such a benefit. Assuming both criteria are met, to the extent the consideration exceeds fair value of the identifiable benefit, such excess is to be characterized as a reduction of revenue; the fair value amount is considered a cost incurred. (The classification of such cost was not addressed.)

In applying this model, the EITF observed that slotting fees and buydowns will generally always be characterized as reductions of revenue; likewise, they observed that this model should be applied regardless of whether the purchaser alters the vendor's product prior to resell (e.g., a cooperative advertising payment made by a component manufacturer to another company that assembles various components in order to market a finished product would be subject to this model).

The EITF has prepared several examples to demonstrate the application of this model to various scenarios. Those interested in researching these issues can contact the FASB at (203) 847-0700 and ask about EITF Issues 00-14 and 00-25.

The accounting required under these issues is considered generally accepted for all companies that prepare financial statements in accordance with accounting principles generally accepted in the United States of America. The effective date for the consensuses reached in these issues is no later than in annual or interim financial statements for periods beginning after Dec. 15, 2001.

Dan Sandstrom is a shareholder in the firm of Don Chapin & Associates, P.A., where he has overall responsibility for the firm's assurance services.

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