ASC 605-50: Accounting for Customer Payments & Incentives

The guidance for accounting for customer payments and incentives is governed by Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers. This standard establishes how a vendor accounts for consideration provided to its customers, including cash, credits, or other incentives. The objective of this guidance is to create consistency in financial reporting and prevent the overstatement of a company’s revenue.

The principles in ASC 606 apply to a wide array of transactions, including when a manufacturer provides an incentive directly to an end-user who buys their product from a retailer. The standard ensures that the economic substance of these transactions is accurately reflected in financial statements.

The Presumption of Revenue Reduction

The guidance in ASC 606 presumes that any payment or incentive from a vendor to a customer is a reduction of the transaction price, and therefore a reduction of revenue. This approach is based on the logic that such payments are adjustments to the price of the vendor’s products or services. Instead of recognizing the full sales price and recording a separate expense, the incentive is netted against the revenue from that customer.

This presumption applies to a broad spectrum of incentives, including:

• Cash payments made to customers
• Credits applied to future purchases
• Coupons and volume-based rebates
• Payments for slotting fees or price protection

For example, if a manufacturer sells $100,000 of goods to a distributor and offers a $5,000 rebate, the manufacturer recognizes $95,000 in net revenue. The revenue reduction should be recorded at the later of when the related revenue is recognized or when the company promises to pay the incentive, whether that promise is explicit or implied.

Qualifying for Expense Classification

While the default treatment for customer payments is a reduction of revenue, ASC 606 provides a path for classifying these payments as a cost or expense. To overcome the presumption, a vendor must demonstrate that the payment is in exchange for a distinct good or service that the customer transfers to the vendor.

A good or service is considered “distinct” if the customer could sell it separately or if the vendor could purchase it from another party. If a vendor receives a distinct good or service, it can account for the payment as a purchase, which would be classified as an expense. If the payment is not for a distinct good or service, the entire payment must be recorded as a reduction of revenue.

Measuring the Fair Value of the Benefit

When a vendor receives a distinct good or service, the accounting depends on whether the vendor can reasonably estimate its fair value. If the fair value can be estimated, the vendor compares it to the payment amount.

If the payment is greater than the fair value of the benefit received, the accounting is split. The portion equal to the fair value is recorded as a cost or expense, while the excess amount is recorded as a reduction of revenue. For instance, a company pays a retail customer $20,000 for an in-store display with a fair value of $15,000. The company would record $15,000 as a marketing expense and the remaining $5,000 as a reduction of revenue from that customer.

If the vendor cannot reasonably estimate the fair value of the benefit, the entire payment must be characterized as a reduction of revenue.

Application to Common Incentive Types

Cooperative Advertising

Cooperative advertising programs are where a vendor agrees to reimburse a customer for a portion of the costs the customer incurs for advertising the vendor’s products. In these arrangements, the advertising is considered a distinct service. The challenge is determining the fair value of the advertising received, which should be the amount the vendor would have paid for similar advertising from another party.

If the reimbursement paid to the retailer is equal to or less than the fair value, the vendor can record the entire payment as an advertising expense. However, if the payment exceeds the fair value, the excess amount must be recorded as a reduction of revenue.

Slotting Fees

Slotting fees are payments made by a vendor to a retailer in exchange for securing space for its products on the retailer’s store shelves. The accounting for slotting fees hinges on whether the shelf space is a distinct service.

In these situations, slotting fees do not represent a distinct service because the shelf space is necessary for the retailer to sell the vendor’s product and is not separable from the sales relationship. As a result, slotting fees are accounted for as a reduction of revenue, with the vendor deducting the fee from the gross revenue recognized from sales to that retailer.

Financial Statement Presentation and Disclosure

The classification of customer payments directly impacts the income statement. When a payment is a reduction of revenue, it is deducted from gross sales to arrive at the net sales figure, which is shown on the face of the income statement.

If a payment qualifies as an expense for a distinct good or service, it is presented within the operating expense section. For example, payments for advertising would be included in “Selling, General, and Administrative Expenses.” ASC 606 also requires companies to disclose their accounting policies for consideration paid to a customer in the notes to the financial statements. This helps users understand the impact of these arrangements on reported revenue and profitability.