As you probably know by now, ASC 606, Revenue from Contracts with Customers, is quite extensive and provides considerable guidance. Some may even refer to it as a novel with an exciting plot focused on revenue recognition! Okay, I’m not sure who would make that analogy, but you get the picture. However, not all of the plot twists are addressed, and it leaves some questions unanswered. While extensive, it can’t possibly cover all of the related issues that might arise in practice. In this blog, we’ll explore one of those unanswered questions, related to shipping and handling activities.
You might be thinking, wait a minute, I thought the FASB issued guidance related to the accounting for shipping and handling activities. And you would be right; they did in the form of ASU 2016-10, which amended ASC 606 and covered a number of other revenue related items as well. However, there is one other consideration related to shipping and handling activities that it didn’t address. Before we highlight that consideration, let’s first review the guidance for shipping and handling activities that was clarified by ASU 2016-10, using an example.
Lumineer, Inc. sells candles, lanterns, and torches through its online store. A customer orders a bronze lantern and it is delivered to their home five days later. When considering ASC 606, specifically step 2 of the revenue recognition process, how many performance obligations exist in this contract with the customer? One? Two? Before we go any further, if you would like more information on Step 2 of the revenue recognition process, be sure to check out our blog. Certainly, the bronze lantern is a performance obligation - it is what the customer ordered after all - but what about the shipping? Is it a separate performance obligation that would have a portion of the transaction price allocated to it and be analyzed separately for revenue recognition in Step 5, thus having a different pattern of transfer to the customer than the good itself?
The answer is maybe. While there is no clear answer in this example, the point to consider is that there may be more than one performance obligation due to the shipping and handling. ASC 606, as amended and clarified by ASU 2016-10, states that shipping and handling activities that occur before the customer obtains control of the related good are fulfillment activities (i.e., not a separate performance obligation). As an accounting policy election, entities can account for shipping and handling activities that occur after the customer has obtained control of a good as fulfillment activities or as a separate performance obligation. The guidance can be summarized in the following chart:
So now we’ve covered the guidance on shipping and handling activities from a revenue perspective, but what about the associated costs? How should those be accounted for and classified in the income statement? The accounting for the associated costs is not addressed in the new standard. However, at the 2017 AICPA Conference on Current SEC and PCAOB Developments, the SEC’s OCA Associate Chief Accountant, Barry Kanczuker, stated that, for shipping and handling accounted for as a fulfillment activity, the SEC staff will not object to classification as cost of sales, nor will they object to a company continuing to apply a previous policy to account for the costs outside of costs of sales. Clearly, if shipping and handling is a separate performance obligation, then the associated costs would be classified as cost of sales. For significant shipping and handling costs classified outside of cost of sales, registrants should consider whether they should disclose the amount of the costs and the line item on the income statement that includes them. These were required disclosures under previous guidance. Basically, while 606 does not specify this disclosure, the SEC is “encouraging” it. While this guidance comes from the SEC and, therefore, relates specifically to public companies, it may also be helpful for non-public entities.
Thanks to the SEC and comments made at the AICPA Conference, we now have an answer to a question left unanswered by ASC 606. If you would like more information about the new revenue recognition standard, be sure to check out our step-by-step guide for revenue from contracts with customers.
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