Wednesday, July 18, 2007

Persuasive evidence of an arrangement

Question: Company A has product available to ship to customers prior to the end of its current fiscal quarter. Customer Beta places an order for the product, and Company A delivers the product prior to the end of its current fiscal quarter. Company A's normal and customary business practice for this class of customer is to enter into a written sales agreement that requires the signatures of the authorized representatives of the company and its customer to be binding. Company A prepares a written sales agreement, and its authorized representative signs the agreement before the end of the quarter. However, Customer Beta does not sign the agreement because Customer Beta is awaiting the requisite approval by its legal department. Customer Beta's purchasing department has orally agreed to the sale and stated that it is highly likely that the contract will be approved the first week of Company A's next fiscal quarter. May Company A recognize the revenue in its current fiscal quarter for the sale of the product to Customer Beta. Answer: No. Generally the staff believes that, in view of Company A's business practice of requiring a written sales agreement for this class of customer, persuasive evidence of an arrangement would require a final agreement that has been executed by the properly authorized personnel of the customer. Question: Company Z enters into an arrangement with Customer A to delivery Company Z's product to Customer A on a consignment basis. Pursuant to the terms of the of the arrangement , Customer A is a consignee, and title to the products does not pass from Company Z to Customer A until Customer A consumes the products in its operations. Company Z delivers product to Customer A under the terms of their arrangement. May Company Z recognize revenue upon delivery of its product to Customer A? Answer: No. Products delivered to a consignee pursuant to a consignment arrangement are not sales and do not qualify for revenue recognition until a sale occurs. The staff believes that revenue recognition is not appropriate because the seller retains the risks and rewards of ownership of the product and title usually does not pass to the consignee. Such arrangements require a careful analysis of the facts and circumstances of the transaction, as well as an understanding of the rights and obligations of the parties, and the seller's customary business practices in such arrangements. The staff believes that the presence of one or more of the following characteristics in a transaction precludes revenue recognition even if title to the product has passed to the buyer. 1. The buyer has the right to return the product and:
  • the buyer does not pay the seller at the time of sale, and the buyer is not obligated to pay the seller at a specified date or dates.
  • the buyer does not pay the seller at the time of sale but rather is obligated to pay at a specified date or dates and the buyer's obligation to pay is contractually or implicitly executed until the buyer resells the product or subsequently consumes or uses the product.
  • the buyer's obligation to the seller would be changed (e.g., the seller would forgive the obligation or grant a refund) in the event of theft or physical destruction or damage of the product.
  • the buyer acquiring the product for resale does not have economic substance apart from that provided by the seller.
  • the seller has significant obligations for future performance to directly bring about resale of the product by the buyer.

2. The seller is required to repurchase the product (or a substantially identical product or processed goods of which the product is a component) at specified prices that are not subject to change except for fluctuations due to finance and holding costs, and the amount to be paid by the seller will be adjusted, as necessary, to cover substantially all fluctuations in costs incurred by the buyer in purchasing and holding the product (including interest). The staff believes that indicators of the latter condition include:

  • the seller provides interest-free or significantly below market financing to the buyer beyond the seller's customary sales terms and until the products are resold.
  • the seller pays interest costs on behalf of the buyer under a third party financing arrangement.
  • the seller has a practice of refunding (or intends to refund) a portion of the original sales price representative of interest expense for the period from when the buyer paid the seller until the buyer resells the product.

3. The transaction possesses the characteristics set forth in EITF Issue 9501 and does not qualify for sales-type lease accounting

4. The product is delivered for demonstration purposes.

If the title to the goods has passed but the substance of the arrangement is not a sale, the consigned inventory should be reported separately from other inventory in the consignor's financial statement as "inventory consigned to others" or another appropriate caption.