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.
Enviva Partners, LP produces utility-grade wood pellets to power generators under long-term contracts. It “procures wood fiber and processes it into utility-grade wood pellets and loads the finished wood pellets into railcars, trucks and barges that are transported to deep-water marine terminals, where they are received, stored, and ultimately loaded onto oceangoing vessels for transport to the Partnership’s principally European customers.” This is the disclosure Enviva Partners gives for its accounting for shipping agreement contracts for wood pellets globally:
Depending on the specific off‑take contract, shipping terms are either Cost, Insurance and Freight (“CIF”), Cost and Freight (“CFR”) or Free on Board (“FOB”). Under a CIF contract, we procure and pay for shipping costs, which include insurance and all other charges, up to the port of destination for the customer. Under a CFR contract, we procure and pay for shipping costs, which include insurance (excluding marine cargo insurance) and all other charges, up to the port of destination for the customer. Shipping costs under CIF and CFR contracts are included in the price to the customer and, as such, are included in revenue and cost of goods sold.
Under FOB contracts, the customer is directly responsible for shipping costs. We have entered into fixed-price shipping contracts with reputable shippers matching the terms and volumes of our contracts for which we are responsible for arranging shipping. (2018 10-Q)
For CIF agreements, Enviva Partners includes its shipping costs and freight in both revenue and cost of goods sold. Depending on when control is transferred, Enviva will recognize its revenue by allocating the total price to each performance obligation. For FOB contracts, Enviva will likely recognize revenue when its third-party shippers pick up the goods for transport.
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.
McEwen Mining, Inc. is a mining company that specializes in producing gold and silver in the Americas. In a recent annual report, McEwen said the following about its shipping terms:
For gold and silver concentrate, there are sales under Cost, Insurance and Freight (‘CIF’) or CIP terms. Revenue is recognized at a point in time when the control passes to the customer.
The Sales under CIP or CIF terms requires the Company to be responsible for providing freight/shipping services (as principal) after the date that the Company transfers control of the metal in concentrate to its customers. The Company, therefore, has separate performance obligations for freight/shipping services which are provided solely to facilitate sale of the commodities it produces. (2019 10-K/A)
This financial statement disclosure helps investors understand the nature of McEwen Mining’s revenue recognition policies. In this case, McEwen determined that the transfer of control for the gold or silver occurs before the goods are actually shipped. This means that there are two separate performance obligations for this transaction and that revenue is allocated to each obligation and recognized at different points in time.
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.
Landstar System, Inc. is a transportation services company that specializes in logistics. Before implementing ASC 606, Landstar recognized revenue when it delivered its products to its customers, but now Landstar recognizes revenue over time. In 2018, the SEC requested that Landstar “discuss the method(s) used to recognize [its] revenue over the transit period, such as a description of the output or input methods and how those methods are applied.”
With respect to the Company’s 2017 fiscal year, freight transportation services provided by truck represented approximately 93% of consolidated revenue and the average length of haul for such services was approximately 732 miles. Based on this information, we estimated that the average transit time for a truck shipment was approximately two to three days, depending on a variety of factors including origin, destination, pick-up time, delivery time, loading and unloading requirements and other factors.
Since the adoption of ASC 606, the Company has used a days-in-transit method to measure the progress of our performance obligations as of a given reporting date… The Company’s performance obligations with respect to freight transportation services are performed over the transit period. We have therefore determined that revenue recognition over the transit period provides a faithful depiction of the transfer of freight transportation services to our customers. (2018 SEC Correspondence)
For a freight and logistics company, revenue recognition will most likely be over time under ASC 606. Landstar has implemented this change using an output method of measuring the number of days completed in the transit period.
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.