I love Amazon Prime, especially around the holidays. Why? The answer is simple – free shipping! Other retailers are starting to follow suit, offering free shipping on purchases, because Amazon is eating into their sales. Do you look at the cost, or lack thereof, related to shipping and handling when you purchase goods online? In other words, do you value shipping and handling services provided by sellers or resellers of goods? Do you think it should it be considered a separate performance obligation by the seller under the new revenue recognition standard (ASC 606)? Does the accounting treatment differ from that under IFRS 15 (IFRS’s version of the new revenue recognition standard)?
In a previous post, we covered identifying performance obligations in the contract, which is step 2 of the new 5-step model within ASC 606. In summary, if a promised good or service is “distinct,” it represents a separate performance obligation. The transaction price is allocated to the various performance obligations and revenue is recognized for each performance obligation, either over time or at a point in time based on the rules within ASC 606.
In this post, we’ll cover the accounting for shipping and handling activities, specifically whether they should be treated as separate performance obligations.
Under existing U.S. GAAP, many companies do not account for shipping and handling activities separately, but rather treat them as fulfillment costs. What are fulfillment costs? Simply, they are the costs incurred to fulfill an order. Some fulfillment costs meet the definition of an asset, such as inventory. Others are deferred as they are eligible for capitalization under ASC 605 or industry practice. However, costs incurred related to shipping and handling do not meet the definition of an asset nor are they eligible for capitalization. As such, they are expensed when incurred. This makes the current accounting easy as the costs to ship the goods are normally matched against the revenue from the sale.
When ASC 606 was issued, stakeholders had diverse views as to whether shipping and handling activities should be considered a separate performance obligation, as it represented a distinct service promised to the customer, or whether they should be considered a fulfillment activity. As previously mentioned, many companies currently consider shipping and handling to be fulfillment activities and, thus, requiring them to account for such activities as a separate promised service, would be a significant change in practice. These companies were concerned about having the systems, processes, or internal controls to account for such activities as separate performance obligations.
ASU 2016-10 Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing
This issue was brought to attention of the Transition Resource Group (TRG) who discussed the matter and, ultimately, advised for clarifying guidance to be issued. ASU 2016-10 was issued in April 2016 and amended ASC 606 for shipping and handling activities as follows:
If the customer takes control of the good before shipment:
- Entities must make an accounting policy election to treat shipping and handling activities as either a fulfillment cost or as a separate promised service (i.e. separate performance obligation).
If the customer takes control of the goods after shipment:
- Shipping and handling activities would always be considered a fulfillment activity.
Assuming control of the goods passes to the customer prior to delivery, most entities would probably choose the election to account for shipping and activities as fulfillment costs, as this is their existing accounting and, quite frankly, it is easier than having to implement new systems, processes, and internal controls. Entities would likely recognize revenue in full when control of the goods passed to the customer. As a result, an entity that accounts for these costs as a fulfillment activity must accrue costs associated with shipping and handling activities when control of the related goods has transferred to the customer.
Let’s look at an example:
In our case, the goods were sold “FOB Shipping Point,” meaning the customer takes control of the goods prior to shipment. As a result, Larry’s Loudspeakers would have to make an accounting policy election to account for shipping and handling either as a fulfillment cost or as a separate performance obligation.
Follow-up question: What about under IFRS?
The IASB decided to not make a similar amendment to IFRS 15. They argued that providing entities with an accounting policy choice would create an exception to the new revenue recognition model, which could reduce comparability between entities. The IASB recognizes that this may lead to differences between IFRS and U.S. GAAP but believes that IFRS 15, as written, is sufficient.
Follow-up question: What if control of the promised goods transfers to the customer after the shipping and handling activities are performed?
In this revised scenario, shipping and handling activities would constitute a fulfillment activity, rather than a separate performance obligation. This would be the case under both U.S. GAAP (ASC 606) and IFRS (IFRS 15).
Closing Thoughts
The accounting policy election provided by ASU 2016-10 is to be applied consistently to similar types of transactions. It is not required to be made at an entity level. However, this election is only available to shipping and handling activities. It should not be applied by analogy to other type of activities such as custodial or storage services, which may be considered separate performance obligations in accordance with ASC 606-10-25-17 or immaterial in the context of the contract in accordance with ASC 606-10-25-16A.
This is just one in a series of blog posts on the new revenue standard that we have summarized here, along with other resources to help you with implementation.
Disclaimer
This post is published to spread the love of GAAP and provided for informational purposes only. Although we are CPAs and have made every effort to ensure the factual accuracy of the post as of the date it was published, we are not responsible for your ultimate compliance with accounting or auditing standards and you agree not to hold us responsible for such. In addition, we take no responsibility for updating old posts, but may do so from time to time.
Comments (13)
Rob M:
Nov 28, 2017 at 05:57 AM
A really good plain-English write-up, that clearly and (almost) completely answers my question. Nice job!
The article stopped short, however, of making the statement that "shipping and handling costs that are incurred after a customer takes control "must be treated as a separate performance obligation" or "should be assessed to determine..". This is an inportant point that is a key part of this overall question.
Rob M:
Nov 28, 2017 at 05:57 AM
A really good plain-English write-up, that clearly and (almost) completely answers my question. Nice job!
The article stopped short, however, of making the statement that "shipping and handling costs that are incurred after a customer takes control "must be treated as a separate performance obligation" or "should be assessed to determine..". This is an inportant point that is a key part of this overall question.
Anne Worstenly:
Jun 27, 2018 at 10:46 PM
Thank you - however for where the goods were sold FOB what is the treatment under IFRS 15 ? It just state there is no policy choice, but not clear how it should be applied ?
Mike Walworth, CPA:
Jun 27, 2018 at 11:50 PM
Thanks for your question, Anne. When I say IFRS 15 doesn't provide for a similar accounting policy election, I mean that for S&H activities that take place AFTER a customer take control of the goods (i.e. FOB Shipping Point), IFRS requires them to be considered a separate performance obligation. Under ASC 606, entities have a choice of considering such S&H costs as either a separate performance obligation or as fulfillment cost (as they are treated if the shipping occurs BEFORE the customer takes control of the goods (i.e. FOB Destination)). Here's what the FASB says about the difference in GAAPs within ASU 2016-10:
IFRS guidance does not allow an entity to make a policy election to account for shipping and handling activities that occur after the customer has obtained control of a good as an activity to fulfill the promise to transfer the good rather than as an additional promised service.
Hope this helps!
Clay B:
Jul 07, 2018 at 11:11 AM
Mike, great comments. Help me clarify, we are a distributor, when the material arrives the warehouse, we add 3% to the value of what we received, calling it a shipping and handling fee, we then tell the sales person their new price to the customer is over and above this shipping and handling fee. Therefore passing it all along to the customer, where does this fall under GAAP? Thanks
Mike Walworth, CPA:
Jul 09, 2018 at 10:40 AM
Thanks for your question, Clay. I am not sure I follow though. Using your example, let's say your company purchased inventory for $100. Do you just record the inventory at $103? If so, what is the remaining credit, some sort of deferred revenue?
Dr. Inventory $103
Cr. Cash $100
Cr. ??? $3
Regardless this would not be proper for GAAP purposes (although perhaps you are only doing this for cost accounting purposes, which I'll readily admit was my worst subject at UF and I've avoided it like the plague after passing the CPA exam).
That aside, the GAAP treatment of S&H shouldn't matter and depends on when the customer takes control of the goods. If the customer takes control of the goods once they receive them (after shipment), then S&H must be treated as a fulfillment cost (i.e. revenue is recognized upon delivery, including S&H fee, and then S&H fee is a cost of sales). Only when the customer takes control of the goods before they are shipped, would S&H be a separate performance obligations. That said, as noted in the blog post, companies have an accounting policy choice to either treat such S&H fees as a separate performance obligation or as a fulfillment cost. In our experience, most entities would chose the later as it is business as usual.
Hope this helps, but I probably need a bit more information about your specific transaction to definitively opine. Perhaps reach out to me directly.
Mike
Jason M.:
Nov 06, 2018 at 05:39 PM
Clear and easy to understand. One follow up question I was hoping you could clarify. When control of the goods takes place after shipment (destination terms), are the fulfillment costs classified in cost of sales or within selling and marketing expenses? I'm not sure if this is an election but I've seen some diversity in practice and am having trouble finding clear guidance. Thanks
Mike Walworth, CPA:
Nov 12, 2018 at 06:15 PM
Very good question, Jason!
The presentation of fulfillment costs related to S&H is not addressed in ASC 606. However, at last year's AICPA National Conference, the Associate Chief Accountant stated the SEC will not object to classification as cost of sales, nor would it object to a company continuing to apply a previous policy to account for such costs outside costs of sales. However, the SEC noted that for significant S&H costs classified outside cost of sales, registrants should consider whether they should disclose the amount of costs and the line item on the income statement that includes them.
Obviously, if S&H were to be considered a separate performance obligation, then the associated costs would classified as cost of sales.
Thanks for reading!!
Ashish Agarwal:
Apr 23, 2019 at 11:14 AM
Hi Mike, excellent note. while you have clarified the classification of fulfillment costs into cost of sales or outside cost of sales. however, what is the appropriate classification in case of IFRS if S&H is treated as a combined performance obligation.
Mike Walworth, CPA:
Apr 24, 2019 at 05:48 PM
Thanks for question, Ashish. See my response to Anne above for a bit more on IFRS. To summarize, if the customer takes control of the goods BEFORE shipment (e.g. FOB shipping point), then S&H cannot be combined with the goods. You essentially have two performance obligations, one for the goods and one for S&H. You recognize a portion of the revenue on the goods when control passes to the customer. The remaining portion of revenue (i.e. the piece allocated to S&H) is only recognized once you've fulfilled your obligation to ship the goods. Of course, I'm sure some companies argue that S&H is immaterial, but that is a judgment call (and one you have to take up with your auditors).
However, if control passes to the customer after shipment (i.e. FOB Destination), then essentially U.S. GAAP and IFRS require the same accounting treatment. You have one performance obligation and revenue is not recognized until control is passed to the customer (as noted in the post).
Hope it helps!
Yosef Barbut:
Mar 22, 2020 at 07:09 AM
Mike,
Do shipping terms (FOB shipping point vs destination) principally determine the timing of control transfer or other/additional factors must also be considered, shipping terms notwithstanding? For example, is "drop ship" from 3rd party suppliers/vendors equally determinable of control transfer? What about past practice of replacing stolen and broken goods?
Thanks
Warren H:
Oct 01, 2020 at 02:46 PM
If a company charges its customers for shipping/handling and an elects to treat the shipping and handling costs as a fulfillment cost, where is the expense classified on the income statement? COGS or selling expense?
Thanks
Patrick S:
Apr 13, 2021 at 08:18 AM
Same question as Warren: If a company charges its customers for shipping/handling and an elects to treat the shipping and handling costs as a fulfillment cost, where is the expense classified on the income statement? COGS or selling expense?
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