When it comes to trade spending for the wine industry, it largely falls on the distributors to handle the details and cost. Wineries, however, aren’t completely off the hook.
Providing a certain level of product support for a sales channel—trade spending—is part of doing business as a food and beverage manufacturer. A lot of the same types of activities apply to the wholesale wine business, but there are differences. The main difference stems from it being a product that follows a three-tier system made up of a winery, distributor, and retailer. This system harks back to when prohibition was repealed in 1933, giving individual states the right to manage the sale of alcohol, after which nearly all states implemented a required system where alcoholic beverages were sold to distributors, that then sold to retail locations.
Trade spending takes on many different forms, such as rebate programs, paying for shelf space (known as slotting), or a buy-one-get-one-half off coupon in the Sunday paper. While a distributor handles the bulk of the sales costs, wineries still need to account for depletion allowances, which are promotional expenses offered to the distributors. These provide an incentive for the distributor to deplete inventory—or sell their inventory through to retailers—and are one of the bigger trade-type expenses that wineries incur.
Here’s how it works: A winery sells products to its distributor (the customer), which takes legal title, and then sells to restaurants and supermarkets. As a sales incentive, a winery will offer the distributor a volume discount or some amount off of each case that’s bought from them when the distributor shows proof they’ve depleted the wine stock.
Netted Against Revenue
Under current US generally accepted accounting principles, trade spending incentives, including depletion allowances and bill backs, are presumed to be a reduction of revenue. That presumption can be overcome if a company can show it received an identifiable benefit from the expense. To demonstrate that, the benefit must be sufficiently separable in that the company could have entered into a separate transaction with a party other than the product purchaser, which is similar to demonstration costs or advertising.
To that end, here are some items that wineries offer to distributors that typically are presented net against revenue:
- Depletion allowances, including bill backs
- Volume rebates
Wineries are often invoiced, or billed back, by a distributor for certain wineries’ products. These expenses often fall in the netted-against-revenue category.
As accountants, we would be remiss if we didn’t mention that ASC Topic 606, Revenue from Contracts with Customers, will change the authoritative guidance for recognition, measurement, and presentation of revenue. ASC Topic 606 is applicable for public business entities for periods beginning on or after December 15, 2017, and for nonpublic business entities in annual periods beginning on or after December 15, 2018. For practical purposes this may or may not change a winery’s recording of revenue and trade spending; however, the new guidance should be consulted in order to consider if changes could impact your company.
It isn’t as prevalent to have exceptions through the three-tier system; however, there are differences in some states. Distributors usually incur a trade spend cost if they make a sale—it’s very much tied to a product—and it’s netted against revenue. However, there are scenarios where you could legitimately record these costs as selling expenses. What the distributor can bill back for could also fall into exception categories.
Say a company sells its product through BevMo!. Doing business with BevMo! typically requires some level of demonstration cost. That cost supports your products—an identifiable benefit that could take place separate from the sales transaction. The result is a selling expense as long as the transaction is deemed representative of fair value.
Or maybe Safeway is running an ad in the paper and it features wine. In absence of the retailer’s ad, the distributor would in theory pay for other advertisements on its own. In this situation, Safeway is doing sales and marketing to support a winery’s product. The distributor retains a benefit and can classify it as a selling expense.
The other exception in the guidance: If the incentive that will be charged against revenue is greater than the actual revenue with that retailer, then the excess of the incentive over the revenue amount is charged to expense. This could be the case when a distributor starts a new relationship with a retailer and is required to pay significant promotional expenses up front but hasn’t generated significant sales to the customer in the same reporting period.
When to Accrue Cost
Wineries and distributors need to be mindful of where they report cost.
From a balance sheet standpoint, distributors should accrue for the cost at the time they make the sale or when they’ve made the offer related to the incentive, whichever is later. However, it’s almost always recognized and accrued when the sale of the wine occurs. And if a winery knows it’s going to offer a certain amount of depletion allowance, then it should record the entire amount. It isn’t common to record less than the incentive offered. It’s also possible to offer an incentive after a sale has been made, but this is rare.
For example, if a depletion allowance requires the distributor to sell through a certain volume to earn the allowance, the cost should accrue at the time the winery believes the incentive will be earned. Generally, other discounts or incentives will accrue at the time of sale.
Simplify with Tracking
Tracking these different items is the biggest challenge for accounting departments at wineries. Not only is it a lot of data to collect but wineries also need to keep track of the offers made to their distributors as well as in the market in order to appropriately accrue for related expenses.
The distributor will prepare an invoice with bill backs to the winery with an attached assessment of their inventory to prove they’ve earned the incentive. While the winery still needs to show what they’ve offered as incentive, it’s pretty easy for the winery to pay those amounts based on the invoices they receive.
Building the accrual—knowing how much to record in the first place based on what sales people are doing in the market—is the challenge along with relating that to the sales that actually happen. To make this process smoother, the winery needs a method to track trade spend costs that are committed to or provided to the distributor.
There are controls you can put in place to help organize this process. Items to consider:
IT system. This could range from an Excel file that tracks each separate promotion by customer to a stand-alone module designed specifically for trade-spend management. Wineries will need to consider a system that can handle increased complexity as their trade spending activity increases with additional customers and distribution channels.
Strong internal controls. It’s critical to have controls in place so sales personnel only offer promotions to distributors that are budgeted and approved. Information needs to be properly routed to the accounting and billing department once incentives are offered to the customer. This allows the finance team to confirm that deductions taken by the customer are legitimate.
Communication. This goes hand in hand with internal controls. If management doesn’t communicate its expectations, then a salesperson may promise something to a distributor that isn’t supported at a corporate level. The goal is to avoid any unpleasant surprises. Solid communication across departments is critical so that trade spend dollars are properly authorized and approved to safeguard the company’s assets along with providing information for accurate accounting and reporting.
We're Here to Help
If you’d like more information on how to classify your trade spend costs or for insight on building proper internal controls to support your promotional activities, contact your Moss Adams professional.
In May 2014 the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers, which established Accounting Standards Codification Topic 606 of the same name. The FASB has issued several accounting standards updates (ASUs) that have modified Topic 606, which will be effective for nonpublic business entities for fiscal years beginning after December 15, 2018. Early adoption is permitted for annual periods beginning after December 15, 2016, and related interim periods. This guidance will have widespread impact on the revenue recognition process, including the recognition of trade spend activities as well as financial statement presentation and disclosure. (See our revenue recognition report for more details.)