After implementing Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers, questions might arise on how to apply the revenue principles.
Your organization could see an increase in bill-and-hold arrangements for your products due to supply chain or production delays across industries, or from lack of physical storage space as you or your customers’ businesses grow and transform.
Bill-and-hold arrangements are more specifically addressed under Topic 606 than under the previous revenue recognition guidance. Explore how Topic 606 can affect bill-and-hold arrangements below and consider the substance of such transactions, and what companies can assess when executing contracts with customers.
What Is ASC Topic 606?
Topic 606 contains an overarching principle: a company should recognize revenue when it transfers goods or services to a customer.
The amount of revenue recognized should represent the consideration to which the entity or the seller expects to be entitled, according to the Financial Accounting Standards Board (FASB).
There’s a five-step process for revenue recognition:
- Identify the contract with the customer
- Identify the separate performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the separate performance obligations in the contract
- Recognize revenue when or as the entity satisfies a performance obligation
Under a bill-and-hold transaction, the timing of the transfer of control of purchased goods to the customer is one of the critical questions for determining when a company should recognize revenue.
Bill-and-Hold Transaction Criteria
Under ASC 606-10-55-83, for a customer to obtain control of a product in a bill-and-hold arrangement, all the following criteria must be met in addition to other criteria in ASC 606-10-25:
- The reason for the bill-and-hold arrangement must be substantive—requested by the customer, for example.
- The product must be identified separately as belonging to the customer.
- The product currently must be ready for physical transfer to the customer.
- The entity can’t have the ability to use the product or to direct it to another customer.
Application of ASC 606 to Bill-and-Hold Transactions
If the control of the goods has transferred to the customer and the four criteria under ASC 606-10-55-83 are met, the bill-and-hold arrangement should then be further evaluated to determine if the arrangement has two performance obligations—producing and storing—which as ASC 606-10-55-84 outlines, may require allocation of the transaction price among the multiple performance obligations.
Evaluating the proper accounting for your company’s fact pattern will involve judgment. Ultimately, a bill-and-hold arrangement must always have substance.
A company manufactures private label snacks for a variety of retail customers. One of those retail customers entered into an agreement with the company to produce a million units of their private label snack so the product stays available and well stocked in its stores throughout the coming year.
The retail customer requested the company manufacture the units in advance and store them at the manufacturing facility until the customer requests delivery over the next six months.
In this example, the company recognized revenue from producing the snack products when the snack products were complete, as title legally passed to the customer per the contract. The arrangement has substance given the customer requested it, the product is clearly identified as belonging to the retail customer who is obligated to pay for the produced snack product, and it is separated from other inventory in the warehouse.
The product is complete, and the private label product is unique and can’t be substituted with another customer’s order due to the unique specifications and branding. The company allocates the transaction price to the private label product, which is recognized at the point at which control has passed to the customer and the four criteria in ASC 606-10-55-83 are met, and to the storage services which it recognizes over time.
The company processes and packages frozen foods and sells to a variety of retail customers. One of those retail customers entered into an agreement to purchase a million units of bagged frozen vegetables to be delivered over the next six months as shelf space becomes available in-store.
Given the company stores all its frozen foods inventory together, and it’s interchangeable between customers to help keep optimum freshness dates, the company doesn’t recognize revenue on this example contract until title passes to the customer upon shipment.
While this arrangement has substance—customer requested deferred delivery due to in-store storage limitations—it doesn’t appear there are facts to support that control of the product has transferred to the customer, and all four criteria in ASC 606-10-55-83 don’t appear to be met.
Best Practices for Evaluating Customer Contracts Under ASC 606
There are many aspects to consider when establishing a bill-and-hold policy. A key one is evaluating customer contracts to help ensure your organization is assessing arrangements in a consistent and accurate manner in accordance with the requirements of the accounting standard.
Assess Whether the Transaction Has Substance
Bill-and-hold transactions should be evaluated to determine if the customer has a substantive business purpose. These types of arrangements shouldn’t be considered a way to increase sales or manage earnings, and being initiated by the seller is a strong indication that it lacks substantive business purpose.
Bill-and-hold transactions should be accounted for consistently and analyzed against your company’s formal revenue recognition policy.
Collaborate Across Teams
A proactive approach should be taken when negotiating, structuring, and entering into contracts with customers that are expected to include bill-and-hold arrangements.
Collaboration among finance, sales, and operations teams is recommended to assess whether the transactions transfer control to the customer in accordance with ASC 606-10-25-30, have a substantive business purpose, and meet the remaining criteria of ASC 606-10-55-83.
Include all Performance Obligations in Writing
A bill-and-hold contract under Topic 606 is expected to have separate performance obligations of production and storage.
The contract with the customer should clearly state the reason the customer requests storage—substance. It should also describe when title transfers to the customer—for example, when the product is completed and available for delivery.
Completed products under bill-and-hold arrangements should be clearly identified as belonging to the customer, ready for physical delivery, and restricted from being used for any other purpose or redirected to another customer.
This can be done through physical segregation within the warehouse or storage facility, clear labeling of customer ownership, and contractual restrictions on alternative uses of the product that are consistently adhered to by the company.
We’re Here to Help
For more information on revenue accounting and reporting considerations in accordance with Topic 606, including bill-and-hold arrangements, contact your Moss Adams professional.
You can also find more insights at our Food & Beverage Practice and Agribusiness Practice.