Providing a certain level of product support for your sales channels—trade spending—is part of doing business when you’re a food and beverage manufacturer. The process, however, isn’t without its issues when it comes to accounting and reporting.
Trade spending takes on many different forms, such as rebate programs, paying for shelf space (slotting), or a buy-one-get-one-free coupon in the Sunday paper. A common misstep is in the presentation of these expenses on the manufacturer’s income statement.
Netted Against Revenue
Under US generally accepted accounting principles, trade spending incentives 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.
The cost paid also must be representative of fair value. In the event the amount paid exceeds fair value, then the additional amount would be netted against revenue.
To that end, here are some items that typically should be netted against revenue:
- Volume rebates
- Manufacturer charge backs
- Slotting fees
Manufacturers 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.
Say a company sells its product through Costco. Doing business with Costco 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 your product. In absence of the retailer’s ad, you would in theory pay for other advertisements on your own. In this situation, Safeway is doing sales and marketing to support your product. You retain 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 customer, then the excess of the incentive over the revenue amount is charged to expense. This could be the case when a manufacturer starts a new relationship with a customer and is required to pay a significant slotting charge upfront but hasn’t generated significant sales to the customer in the same reporting period.
When to Accrue Cost
Manufacturers need to be mindful of where they report the cost—from a balance sheet standpoint, they should accrue for the cost at the time they make the sale or when they believe it’s probable they’ll incur the cost.
For example, if a rebate program requires the customer to obtain a certain level of sales volume to earn the rebate, the cost should accrue at the time the manufacturer believes the incentive will be earned. Generally, other discounts or incentives will be accrued for at the time of sale.
Simplify with Tracking
Tracking these different items can be a complex challenge for the accounting department—it’s a lot of data to collect.
To make this process smoother, the manufacturer needs a way to track trade spend costs that are committed to or provided to the customer. We often see companies subject to short pays from their customer, and the company isn’t able to identify which promotion the short pay pertains to.
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. Companies 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 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 customer 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 issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers, which will be effective for privately held companies for fiscal years beginning after December 15, 2018 (per deferral under ASU 2915-14). This guidance will have widespread impact on the revenue recognition process, including the recognition of trade spend activities. (See our revenue recognition report for more details.) Separate guidance on the impact of the new revenue recognition standard will be released at a later date.