Revenue Recognition: Accounting for Shipping and Handling (ASC 606 / IFRS 15)
I love Amazon Prime, especially around the holidays. Why? The answer is simple – free shipping! 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 this post, we’ll cover the accounting for shipping and handling activities, specifically whether they should be treated as separate performance obligations under both U.S. GAAP (ASC 606) and IFRS (IFRS 15).
Reminder: Identifying performance obligations under ASC 606
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.
Issues involving shipping and handling
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.
Example: Accounting for shipping and handling activities
Solution: Accounting for shipping and handling under U.S. GAAP (ASC 606)
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.
Solution: Accounting for shipping and handling under IFRS (IFRS 15)
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.
Want to learn more about shipping and handling and other revenue recognition issues? Check out our Revenue Recognition Topic Page or our ASC 606: Revenue from Contracts with Customers eLearning course collection (7 courses; 5.5 CPE). Need a course on IFRS 15? We got that too!
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Disclaimer
This post is for informational purposes only and should not be relied upon as official accounting guidance. While we’ve ensured accuracy as of the publishing date, standards evolve. Please consult a professional for specific advice.
