The new revenue recognition standard and the explosion in online sales are prompting some retailers to change the time at which e-commerce revenue is recognized from customer delivery to shipping point, according to a recent report.
Last month, Ernst Young and the Retail Industry Leaders Association released their 2018 Retail Accounting Policy Survey. They polled finance executives from more than 40 companies across the retail industry about more than 100 questions to determine how retailers are applying the revenue recognition standard and other accounting rules related to inventory in their financial reporting.
The survey found that retailers have changed the timing at which e-commerce revenue is recognized as a result of the new rev rec standard and the growth in online shopping. In addition, a small number of retailers are allocating online sales to stores in their impairment analysis.
“Generally it was a big exercise for retailers to go through, as it would be with any new accounting standard,” said EY partner Mindy Dragisich. “Two of the more visible areas from a retail perspective were where the standard now allows you to evaluate who controls the goods or services, and that is really the point in time at which you would recognize revenue. Through the standard, there are now indicators that allow an entity to evaluate at what point control has transferred. With the new standard, most retailers evaluated those indicators and determined whether or not they would change their revenue recognition policy, primarily for their ecommerce business.”
The dominance of Amazon has forced most brick-and-mortar retailers to find ways to try to compete in the e-commerce space, and now they have to take into account the new revenue recognition standard.
“Today most retailers recognize their e-commerce business once the product is delivered to the customer’s door,” said Dragisich. “As part of this new accounting standard, we found that there were some changes to that in terms of the retailers going through the analysis and determining the point of control was actually the shipping point and actually accelerating the timing of when they would recognize the revenue for products that are more e-commerce revenue.”
For e-commerce sales, the survey found 63 percent of the retailers surveyed recognized revenue under the older standard, ASC-605, upon delivery to a customer, while 22 percent recognized it at the shipping point, that is, when the goods were transferred to a third-party carrier. The survey found that only a small portion of retailers changed the time at which e-commerce revenue is recorded from delivery under ASC 605 to a shipping point under ASC 606, with 59 percent recognizing e-commerce revenue upon delivery to a customer and 29 percent at the shipping point.
Aside from retail, other industries such as manufacturing have faced their own issues in adjusting to the revenue recognition standard. Jon Sutter, senior manager of the revenue recognition Implementation team at the accounting firm Elliott Davis, works with clients in the firm’s manufacturing and distribution group. “The area that’s taking the most time is on step 5 of the model, and the timing of recognition,” he said. “The new rule says that if you’re making a specific unit and you have that legal right for collection, that you’re required to recognize revenue over time. It’s a change from the risk and reward model to this control model. It becomes an area of significant judgment, which is what FASB intended to do. For manufacturers, that’s one of the challenging areas: Should we be book revenue over time, and does it qualify? This is step 4. And it’s really by industry that you see the challenges. In manufacturing, in my view, it’s the timing of recognition.”
He sees other challenges in the technology industry. “If you talk to a technology or a software company, one of the challenges is more on step 2, performance obligations,” said Sutter. “Should we be bifurcating these different promises as a standalone value? It really depends on the industry. Each industry has its set of challenges.”
For the retail industry, the EY and RILA survey found that approximately 29 percent of the respondents have changed the timing at which they recognize revenue for their e-commerce business, from delivery to the customer to the shipping point now, recognizing the revenue sooner. Despite the growth in e-commerce and international operations, a 51 percent majority of respondents in the survey continue to report just one segment. “Retailers are generally expanding their e-commerce platforms, whether that’s the online website, whether that’s an app, or whatever it might be,” said Dragisich. “One of our observations was that with all of that expansion and growth, retailers have continued to report just one segment under the accounting guidance. Will this change over time? As e-commerce evolves and becomes a larger part of the business, I think it could.”
Inventory Changes
The report also looked at how retailers are keeping track of inventory. It found that 78 percent of the respondents use third-party inventory-counting firms to help them perform physical inventory, and 62 percent rely on a SOC-1 (service organization controls) report for the inventory-counting firm, When asked what percentage of their inventory is valued using the LIFO (last in, first out) method, 70 percent of the respondents said 90 to 100 percent of inventory is valued through LIFO. A small percentage of retailers are allocating online sales to stores in their Accounting Standards Codification 360-10 Impairment or Disposal of Long-Lived Assets impairment analysis. The primary methods used to estimate inventory impairment are review of aging inventory (73 percent), specific identification of the product (68 percent), analysis of days of supply on hand (46 percent), review of seasonal catalog or closeout lists (44 percent) and review of margins (41 percent).
Relatively few retailers seem to be using RFID (radio-frequency identification) technology in the physical inventory management process or RPA (robotic process automation) in the finance function, but their use is expected to expand. No retailers said they were using RFID as the only source to update item accuracy in the general ledger. While 71 percent indicated they were updating item accuracy based on physical counts only, 29 percent said they were updating item accuracy based on a combination of RFID and/or physical inventory counts.
“It was surprising to us to see how few retailers were using RFID,” said Dragisich. “It’s a technology that’s been out there for years. While it’s expensive, given that information management and getting the right amount of products to the right location have become so important in the digital age, we expected to see more retailers using this technology a little bit more than we thought. I think we saw only 17 percent of retailers actually using RFID, and that’s generally only in certain product categories, not across the whole base or items. For us, it was a little bit eye opening that it was so low. We personally at the firm have received a lot of questions from our clients on RFID and who’s using this technology. The idea is that retailers want to get to a point where they are replacing the annual physical inventory that happens at stores with RFID, and using RFID to annually update their quantity counts as well as their shrinks. So I think this is something that’s definitely top of mind for the finance folks and they’re really starting to ask a lot of questions about that.”
Robotic Process Automation
Similarly the survey found that only 15 percent of retailers were using robotic process automation, and only 17 percent are using offshore shared services for their accounting functions. “The other thing that was a little bit surprising to us as well is we asked a lot of questions about shared service centers and offshoring any of the accounting and finance functions, and then really how retailers are using RPA in their finance function,” said Dragisich. “Again, we were surprised to know that only about 17 percent of our respondents actually have some sort of shared service center within the accounting function, as well as only 15 percent employ some sort of RPA in their finance function. This is definitely an area the firm EY has been spending a lot of time with our clients, including retailers, who are asking a lot of questions about RPA and how they can actually institute RPA in their finance function. Frankly it’s not something that is widely used in finance today, but it’s not something that’s new to retailers. I would say most retailers are using RPA functionality in other areas of the business.”
Technology such as RPA may help retailers and other companies deal with all the changes with revenue recognition and other accounting standards. Public companies are already supposed to be using the standard, and private companies will need to begin using it this year.
Sutter believes they shouldn’t wait too long. “Private companies are required to adopt in 2019, and a lot of them are very slow to implement this new standard,” he said. “Most companies put it on the back burner. I would estimate between 10 to 15 percent of private companies that we’re seeing have adopted it, but the large majority are still learning about the standard, but have not adopted it. There are quite a lot of companies that haven’t done anything yet. They are likely going to wait until the first quarter in 2020, when the standard is going to be necessary. If companies have quarterly debt covenants, which a lot do, or if they have any type of stockholder or internal reporting they need to get on U.S. GAAP, they really need to be implementing now or at a minimum try to figure out if there is any material change that is going to impact their organization.”
Even though the rev rec standard is supposed to reduce the industry-specific complexity of the old rules, Sutter isn’t buying it. “FASB came out and said it’s trying to create a framework that has less complexity and reduce the volume of relevant guidance,” he noted. “They eliminated 200-plus different substandards to create one uniform standard, but folks say this doesn’t seem like it’s reducing any complexity.”
