Understanding the Impact on Revenue Recognition and Inventory Based on International Shipping Terms
Does your company currently have international sales? Do you plan to begin selling merchandise in an international marketplace now or in the future? If the answer is yes, then having knowledge of when revenue is properly recognized is critical to accurate financial reporting. Even if your company does not sell products internationally, you may be purchasing items from an international vendor. Understanding when the products become part of your inventory and when you are liable for them is equally important.
It seems like the world continues to shrink, making it more likely that your company will be conducting international commerce. Understanding revenue recognition for international sales can provide management with potential advantages when negotiating contracts with large international customers or vendors. A better understanding of these terms will allow business owners to have accurate financial data which will permit them to make better day-to-day operational decisions as well as long-term strategic plans.
When is revenue or inventory and the related liability recognized for financial purposes? That’s easy when the sale is made! Sounds simple but, the challenge is determining when the sale is actually made. In the United States, there are two basic shipping terms; free on board (FOB) shipping point and free on board destination. These two are fairly easy to understand. With FOB shipping point the sale occurs at the seller’s shipping dock and with FOB destination the sale occurs when it arrives at the buyer’s receiving dock. On the other hand, in international business there are approximately a dozen different shipping terms and each has different characteristics associated with three main components; cost, risk and insurance.
In an effort to improve understanding of international shipping, International Commercial Terms were published by the International Chamber of Commerce (ICC). These terms are intended to provide clear guidance on the tasks, costs and risks associated with the transportation and delivery of goods to the international community. Even with the guidance provided by the ICC, there can still be different interpretations of the various shipping terms.
For international transactions, the sale, or delivery of the goods can take place anywhere from packaging at the seller’s premises, receipt at the shipping port and the destination port, delivery to the destination, unloading of the goods at its location by the buyer, or other various steps throughout the transportation process. Some of the most common international shipping arrangements are Ex Works (EXW), Free Alongside Shipping (FAS), Cost Insurance and Freight (CIF) and Delivered Duty Paid (DDP). Under EXW, delivery takes place when the seller places the goods at the disposal of the buyer at the seller’s premises (or another named place). With Free Alongside Ship (FAS), delivery is when the seller places the goods alongside a vessel at a named port of shipment; for Cost Insurance and Freight (CIF), delivery is when the seller places the goods on board a vessel at the port of shipment; and for Delivery Duty Paid (DDP), delivery is when the goods have cleared import customs and are ready for unloading at the named place of destination. These are just a few of the more common shipping terms for international transportation and as you can see the timing of the sale is different for each one. One key to implementing accurate revenue recognition of international transactions is in educating your personnel about these differences.
When conducting international business it’s easy to get overwhelmed with the numerous shipping terms and then gain an understanding what is required by the buyer and the seller for each method. The logistics and documentation that must be maintained can also be time-consuming.
However, knowledge of the operational aspects of international trade is only part of the equation. Accounting for international transactions is the other part and (often times) is overlooked because of a lack of knowledge of the differences in international transactions compared to domestic transactions. Having better awareness of international trade can have a profound impact on how you approach and conduct your business in the international marketplace and will better enable you to accurately report your company’s revenue.
Working with a CPA who is knowledgeable with domestic and international shipping terms as well as revenue recognition standards will help raise your awareness and improve your accuracy in reporting revenue.
Article Contributed by Jamie Iseminger, CPA, MBA
Senior Audit Manager
About MKS&H: McLean, Koehler, Sparks & Hammond (MKS&H) is a professional service firm with offices in Hunt Valley and Frederick. MKS&H helps owners and organizational leaders become more successful by putting complex financial data into truly meaningful context. But deeper than dollars and data, our focus is on developing an understanding of you, your culture and your business goals. This approach enables our clients to achieve their greatest potential.