1. Accounting Treatment of Receivables from Suppliers
How should the amounts received by dealers from suppliers be accounted for?
Case: Company A primarily engages in automobile dealership, with its main profit sources being the gross profit from buying and selling and rebates from various automobile manufacturers. At the end of the reporting period, there were significant receivables from rebates in the company’s other receivables. According to the contract terms between Company A and the suppliers (i.e., automobile manufacturers), the contract is a buyout-style dealership, where suppliers provide rebates based on Company A’s sales performance of their brand of automobiles at a certain percentage each year. Meanwhile, Company A provides marketing promotion services for some new models to the suppliers without charging separately for these marketing services. How should the amounts received by Company A from the suppliers be accounted for?
Analysis: According to enterprise accounting standards and related regulations, revenue refers to the total inflow of economic benefits that arise from the enterprise’s daily activities, which leads to an increase in owners’ equity and is unrelated to the capital invested by owners, including sales revenue, service revenue, etc. The acquisition of inventory should be measured at cost. The cost of purchased inventory refers to all expenditures incurred by the enterprise from procurement to storage, including purchase price, related taxes, transportation costs, and other expenses attributable to the inventory procurement cost.
The key judgment in this case is whether the consideration received by Company A from the automobile manufacturers is purely a cash rebate based on sales performance or includes compensation for the marketing services provided by Company A. If it is solely a cash rebate based on sales performance, then the entire consideration received should be treated as an adjustment to the purchase price of inventory, thereby reducing the cost of inventory or the cost of main business operations accordingly. If the marketing services provided by Company A to the suppliers are clearly distinguishable goods and their fair value can be reasonably estimated, then the consideration should be split, recognizing the portion attributable to the marketing services as revenue, while the remaining portion should be recognized as receivable rebates and correspondingly reduce costs. At this point, Company A needs to provide sufficient evidence to demonstrate that the marketing services it provided constitute a clearly distinguishable performance obligation with a reliably measurable fair value.
(Source: Shanghai Stock Exchange Accounting Regulatory Dynamics, 2021, Issue 4)
2. Accounting Treatment of Revenue from Pharmaceutical Research
Can revenue from pharmaceutical research be recognized upon reaching the milestone nodes stipulated in the contract?
Case: Company A’s main business is to provide pharmaceutical research services to major pharmaceutical companies. Company A signed a contract with the client regarding the pharmaceutical research services, stipulating the main processes, which are generally divided into several milestone nodes. When the research progress reaches each milestone node, the client is required to pay non-refundable milestone payments, which reflect the progress of the completed work at each milestone node. The setting of milestone nodes and the payment ratios for each node do not differ significantly from comparable companies in the industry. Both parties agreed that the research results and intellectual property rights arising from the performance of the contract belong to the client, and during the research process, Company A is required to submit the research results formed during the research process to the client in a timely manner, and the client will confirm the milestone nodes.
Additionally, Company A provides the client with unconditional access to the project materials and site, cooperating with the client’s related work. The client can monitor the specific progress of the research work in real-time through the project leadership group and can send personnel to the site for auditing, tracking, and inspection at any time. Assuming the contract contains only one performance obligation and meets the conditions for recognizing revenue over a period of time, can Company A recognize revenue upon reaching the milestone nodes stipulated in the contract?
Analysis: This case requires attention to two aspects.
First, whether the use of milestones to determine performance progress is appropriate under the time period method. According to the relevant provisions of the “Enterprise Accounting Standards No. 14 – Revenue” (revised in 2017), “reaching a milestone” is an output indicator for determining performance progress. However, the notice issued by the Ministry of Finance in 2021 emphasized that “enterprises should analyze whether the different milestone nodes stipulated in the contract appropriately represent the performance progress. If the milestone nodes can appropriately represent the performance progress, it indicates that using ‘reached milestones’ to determine performance progress is appropriate; if the enterprise has transferred significant control of goods to the client between the various milestone nodes stipulated in the contract, it is likely to indicate that using ‘reached milestones’ to determine performance progress is inappropriate, and the enterprise should choose other output indicators or methods to determine performance progress.” Therefore, enterprises need to assess whether the milestone payment progress matches the actual performance progress based on actual circumstances, and cannot simply treat the payment progress stipulated in the contract as the performance progress.
Second, in the case of recognizing revenue using the milestone method, it is necessary to consider the accounting treatment of the milestone nodes between the balance sheet dates. According to Article 12 of the “Enterprise Accounting Standards No. 14 – Revenue” (revised in 2017), “When the performance progress cannot be reasonably determined, if the costs incurred by the enterprise are expected to be compensated, revenue should be recognized based on the amount of costs incurred until the performance progress can be reasonably determined.” Between the various milestone nodes, performance progress is usually not reasonably determinable. At this point, the company should estimate whether the incurred costs can be reasonably compensated based on contract terms, historical experience, expected performance conditions, client credit conditions, and other factors. If compensation is expected, revenue should be recognized based on the incurred cost amount; if compensation is not expected, the incurred service costs should be included in the current profit and loss without recognizing related revenue.
(Source: Shanghai Stock Exchange Accounting Regulatory Dynamics, 2021, Issue 5)
3. Identification of Individual Performance Obligations in General Contracting
How to identify individual performance obligations in a general contracting contract that includes multiple engineering contents?
Case: Company A’s business mainly provides comprehensive services such as park planning and design, amusement equipment research and production, and engineering construction management for theme parks. The contracts signed with clients mainly have two models: one is a general contracting contract for the entire theme park from planning to completion, and the other is where the client separately bids for different stages of service content, and Company A obtains one or several of the jobs. The price of the same job may vary significantly due to the specific needs of the client. In March 2021, Company A signed a general contracting contract with client Z, agreeing that Company A would provide three services: planning and design of a theme park, research and production of amusement equipment, and engineering contracting management. All three services have highly customized and non-standardized characteristics, and the contract stipulates the work tasks, work results, settlement amounts, etc., for each stage, and clearly states that acceptance will occur upon the overall delivery of the theme park.
Should Company A identify the general contracting contract for the theme park as a single performance obligation, or should it identify the planning and design of the theme park, research and production of amusement equipment, and engineering contracting management as separate performance obligations?
Analysis: In this case, a comprehensive analysis of the relevant agreements and business characteristics of the general contracting contract suggests that it may be more reasonable for Company A to identify the general contracting contract for the theme park as a single performance obligation.
According to Article 9 of the “Enterprise Accounting Standards No. 14 – Revenue” (revised in 2017), a performance obligation refers to the commitment of the enterprise to transfer distinguishable goods to the client in the contract; Article 10 states that if the goods promised by the enterprise to the client meet the following conditions, they should be treated as distinguishable goods: (1) the client can benefit from the goods themselves or from their use together with other readily available resources; (2) the commitment to transfer the goods to the client can be distinguished from other commitments in the contract.
The following situations usually indicate that the commitment to transfer the goods to the client cannot be distinguished from other commitments in the contract: 1. The enterprise needs to provide significant services to integrate the goods with other goods promised in the contract into the agreed combination output to be transferred to the client. 2. The goods will significantly modify or customize other goods promised in the contract. 3. The goods are highly related to other goods promised in the contract.” The key in this case is to determine whether the overall delivery of the theme park is a distinguishable good or whether the phased results formed by the planning and design of the park, research and production of amusement equipment, and engineering contracting management are distinguishable goods.
First, determine whether the client can benefit from the use of the phased results formed by the three works separately. The planning and design of the park, research and production of amusement equipment, and engineering contracting management included in the general contracting contract signed by Company A can be provided to clients separately or in combination through bidding in Company A’s daily operations, and the client can benefit from them, which meets the condition in Article 10 of the revenue standards that “(1) the client can benefit from the goods themselves or from their use together with other readily available resources.”
Second, determine whether the phased results formed by the three works transferred to the client can be distinguished from the phased results formed by the other two works. The general contracting contract stipulates that acceptance will occur upon the overall delivery of the theme park. Although Company A and the client have also agreed on the work tasks, work results, settlement amounts, etc., these terms are essentially aimed at controlling the project’s progress and determining payment nodes. What the client seeks to obtain is still the commitment to the overall delivery of the theme park. Given that the planning and design of the theme park, research and production of amusement equipment, and engineering contracting management all have highly customized and non-standardized characteristics, Company A needs to consider these three works as highly related, where each work may lead to significant modifications or customizations of the other works, and only upon the completion of all three works can the overall delivery goal of the theme park be achieved. The phased results formed by the planning and design of the theme park, research and production of amusement equipment, and engineering contracting management do not meet the condition in Article 10 of the revenue standards that “(2) the commitment to transfer the goods to the client can be distinguished from other commitments in the contract.”
In summary, since the two conditions in Article 10 of the revenue standards cannot be simultaneously satisfied, it is more reasonable to identify the general contracting contract as a single performance obligation.
(Source: Shanghai Stock Exchange Accounting Regulatory Dynamics, 2021, Issue 6)
4. Direct Sales Model of Productized Software
1. Case Background
On December 22, 2019, Company A signed a contract with Company B to authorize the use of its productized data exchange platform management software to Company B for a period of 3 years. On the same day, Company A sent the software and a temporary key valid for 10 days to Company B via email, allowing Company B to experience and trial all functions of the software for free during the trial period. Before the trial period ends, Company B has the right to unilaterally terminate the contract without any conditions. After the trial period ends, if Company B does not terminate the contract, the contract becomes effective. The contract stipulates that Company B should pay 100,000 yuan at the end of each month within 6 months after the contract becomes effective (i.e., January 1, 2020), with a total contract price of 600,000 yuan. To facilitate payment, Company A only provided Company B with a temporary key valid for 6 months on the effective date of the contract, which allows normal use of all software functions. After Company B pays the full price, Company A will provide a formal key valid until the expiration of the 3-year authorization period. The contract also stipulates that Company A must provide Company B with 10 days of free software usage training and one year of free software upgrades. The software sold by Company A can function normally without subsequent training or upgrade services.
2. Key Issues for Discussion
(1) Timing of Contract Formation. Company B obtained the software and the 10-day temporary key on December 22, 2019, and can use all functions of the software normally. However, since Company B has the right to unilaterally terminate the contract before the trial period ends without compensation to Company A, there is no contract defined under the new revenue standards before the trial period ends. After the trial period ends, if Company B does not choose to terminate the contract, the contract becomes effective, and the rights and obligations stipulated in the contract become legally binding on both Company A and Company B, thus forming a contract.
(2) Identification of Performance Obligations in the Contract. Company A’s commitments in the contract include software licensing, training, and software upgrade services. Since the software can function normally without subsequent training and upgrades, Company A can fulfill its commitment to grant Company B software licensing independently without providing other services. The training and upgrade services do not significantly modify the software, and there is no high correlation between them, nor has Company A integrated these services into a group of combined outputs. Therefore, the software licensing, training services, and software upgrade services are distinguishable and should be treated as separate performance obligations. Company A should allocate the transaction price to these three performance obligations based on their relative standalone selling prices and recognize revenue separately as each performance obligation is fulfilled.
(3) Performance Obligation at a Point in Time or Over Time. The software license has independent functionality and can function normally without subsequent training and upgrade services, and the benefits Company B derives from the software license will not be significantly affected by Company A’s related activities. Therefore, the software license does not meet the conditions for being a performance obligation fulfilled over a period of time and should be treated as a performance obligation fulfilled at a point in time.
(4) Timing of Revenue Recognition. On January 1, 2020, after obtaining the 6-month temporary key, Company B can use all functions of the software normally and begin to benefit from it. Although Company A only provided a temporary key before Company B paid the full price, this arrangement is merely a means for Company A to facilitate payment from Company B and does not affect Company B’s ability to benefit from using the software. Therefore, Company A should recognize revenue on January 1, 2020.
(Source: Beijing Regulatory Communications, 2021, Issue 2)
5. Licensing of Productized Software
1. Case Background
Company A signed a contract with Company B to authorize the use of its credit analysis software system, with the charging method for Company B being: Company B pays a total annual license fee of 10,000 yuan on January 1, 2020. Company B has the right to choose to renew for another year at the same price at the end of 2020. If not renewed, the new price after the increase will apply. In 2021, the expected price for the software license is expected to increase to 12,000 yuan per year. Additionally, Company A signed a contract with Company C to authorize the use of its credit analysis software system, allowing the other party to generate personal credit reports through the system. The software license period is from January 1, 2020, to December 31, 2020. The charging method for Company C is: Company A charges 100 yuan for each personal credit report generated through the system, with no minimum purchase quantity stipulated.
2. Key Issues for Discussion
(1) Additional Purchase Option. The contract signed between Company A and Company B includes an additional purchase option, which should be assessed to determine whether this option provides a significant right to Company B. Since only customers who have signed this contract have the right to choose to renew, and the price enjoyed by exercising this option is 20% lower than the market price, it can be considered that the renewal option provides a significant right to the customer and should be treated as a separate performance obligation, with the transaction price allocated to this performance obligation.
(2) Exception for Sales or Usage-Based Royalties. Company A’s commitment to Company C is to grant the other party a license for the intellectual property of the software system, assuming that this license is a performance obligation fulfilled at a point in time. According to the exception for royalties based on actual sales or usage, Company A should recognize the relevant revenue when Company C actually uses the software system to generate personal credit reports.
(3) Contract Changes. Following the previous example, on October 1, 2020, Company A signed a supplementary agreement with Company B. It stipulates that the original licensing contract is terminated immediately, and at the same time, a new three-year software usage license is granted to Company B, with the license period from January 1, 2020, to December 31, 2022, and the scope of the license remains unchanged, with no additional goods or services added. The license fee is 30,000 yuan, deducting the 10,000 yuan already paid under the original contract, and Company B will pay an additional 20,000 yuan on October 1, 2020.
The contract change between Company A and Company B does not alter the license granted to Company B. The original software licensing contract has not effectively terminated but has extended the expiration date by two years, meaning the contract change adds two years of clearly distinguishable software licensing. Since the original contract is a performance obligation fulfilled at a point in time, the relevant intellectual property license was transferred to Company B on January 1, 2020, and Company A has fulfilled its performance obligations under the original contract. For the two-year extension of the software license, Company B can use this license and begin to benefit from it starting from the beginning date of the authorization on January 1, 2021. Therefore, Company A should recognize revenue for the software license on January 1, 2021. [Note: When extending or renewing contracts that grant customers intellectual property licenses, the timing of revenue recognition may differ between international standards and U.S. standards: U.S. standards generally hold that companies cannot recognize revenue for granting customers intellectual property licenses earlier than the start date of the extension or renewal; international standards suggest that the timing should be determined based on relevant facts and circumstances, treating the extension or renewal as a new licensing contract or as a change to the original contract, which may lead to earlier revenue recognition in some cases. Considering the timing of signing the extension or renewal contract is somewhat controllable for enterprises, to reduce the potential for manipulation and enhance the comparability of financial information, this case is written in accordance with U.S. standards.]
Although Company A’s payment for the extension license fee occurs before it gains control of the license, since the payment date of October 1, 2020, and the date of control transfer for the extended license is less than one year apart, Company A may disregard whether this advance payment contains a significant financing component. If it exceeds one year, it would need to consider whether it contains a significant financing component.
(Source: Beijing Regulatory Communications, 2021, Issue 2)
