The final step of the Accounting Standards Codification (ASC) 606 five-step model states that a company recognizes revenue when control of a promised good or service is transferred to the customer. We explain this guidance generally in a separate article, Determining the Transfer of Control. This article explores additional complexities related to shipping terms that may transfer control at a different point in time than physical possession. For example, a product may be shipped weeks before the buyer has physical possession of the related goods, but the shipping terms give the buyer control at the shipping point.
ASC 606-10-25-30 provides general indicators that help companies determine when control transfers to a customer, including:
- The seller has a right to payment
- Legal title transfers to the customer
- The customer obtains physical possession of the goods
- The customer accepts the risks and rewards of ownership
Not surprisingly, shipping terms can impact each one of these indicators. Although shipping terms alone do not determine when control of a good or service is transferred, they often play a key part in determining the number of performance obligations and the appropriate revenue recognition.
FOB vs. CIF Shipping Agreements
Due to varying legal interpretations of international trade agreements, the International Chamber of Commerce developed common rules and guidelines that govern shipping agreements. Free on Board (FOB) and Cost, Insurance, and Freight (CIF) are two common international shipping agreements that dictate whether the seller or the buyer shoulders the liability while goods are in transit, and who has legal title of the goods throughout delivery. These agreements also specify the responsibilities of the buyer and seller and each party’s acceptance of the risks and rewards of ownership.
An FOB agreement generally assumes all liability falls on the buyer once the goods leave port. This means that the customer bears the risks and rewards once the goods leave port. A CIF agreement, in contrast, states that the seller is responsible for paying the costs to safely transport the goods to the buyer and the seller retains responsibility until the buyer has the goods in hand. This means that the customer does not yet bear the risks and rewards of ownership until the goods are received.
Accounting Guidance Under ASC 606
ASC 606 addresses two primary questions when FOB or CIF shipping arrangements exist:
- When does transfer of control occur?
- Is the shipping service a separate performance obligation?
Generally, for an FOB agreement, control transfers to the buyer when goods leave port because that is when the customer obtains the risks and rewards of ownership, and often the legal title to goods. For a CIF agreement, however, control usually transfers to the buyer when the goods arrive. This means the customer obtains the risks and rewards of ownership, and often the legal title to goods, and at that point.
The next question is whether the shipping services constitute a separate performance obligation. Under most CIF shipping agreements, shipping services—which are paid by the seller—are not usually treated as separate performance obligations. This is because control of the goods is not considered transferred until delivery, and the shipping service is probably immaterial relative to the contract. Therefore, one performance obligation suffices. Revenue is often recognized at a point in time for these contracts.
In practice, for CIF contracts, companies may use the average shipping time to determine when its product has been delivered and when to recognize revenue. For example, if it takes an average of four days for a company to ship goods to a certain country, then (under a CIF contract) revenue may be recognized four days after the company ships the goods to that country. Processes and controls must be in place to calculate this average delivery time and ensure that it would not materially differ from recognition based on actual delivery times.
If the transfer of control occurs when the goods are shipped (such as in an FOB contract), shipping services provided by the seller may be treated as a separate performance obligation because the transfer of goods and the provision of shipping services happen at different times. When this is the case, the transaction price must be allocated across the promised goods and the shipping services based on their respective relative selling prices. To learn more about allocating the transaction price to multiple performance obligations, read Standalone Selling Prices in ASC 606 and Allocating Variable Consideration in ASC 606.
Revenue Recognition for Freight and Logistics Companies
In this article, we have addressed revenue recognition for companies (the sellers) that use shipping services to transport goods to their customers (the buyers). However, it may be helpful to distinguish how companies specializing in shipping, freight, and logistics ultimately recognize revenue.
A freight and logistics company often stands in the middle between buyers and sellers. These companies specialize in delivering goods, often internationally, to buyers on behalf of sellers. The example below highlights how a freight and logistics company recognizes revenue over time per ASC 606.
The timing of revenue recognition can vary depending on what contract terms a company has negotiated with its customers, such as FOB or CIF. Determining when the transfer of control has occurred and how many performance obligations exist in any given revenue contract is crucial, especially when shipping terms are significant. Revenue recognition for shipping agreements may also vary with industries, like the freight and logistics company noted in this article. Determining when the transfer of control occurs for goods or services is becoming increasingly important as the global economy’s international trade surges in a post-COVID environment.