Customer Classification: Cooperative Advertising Arrangements

ILLUSTRATION: COOPERATIVE ADVERTISING ARRANGEMENTS
EXAMPLE 1Facts: Company D provides satellite television services. It sells the hardware (a satellite dish and receivers) necessary to receive its services through retailers that sell the hardware and arrange installation. The hardware is purchased from Company D and retailers receive an advertising allowance of $100 for each receiver sold and activated. That allowance is shown as a deduction on the related invoice. The retailers are expected to include Company D’s products and service in local advertisements. However, retailers are not required to and, therefore, do not provide any documentation to Company D on how the advertising allowance was used.

Vendor Classification Discussion: The first condition of the EITF 01-9 model is not met. Company D cannot identify the benefit, if any, that has been received because retailers do not provide documentation of any advertising that has been run. Therefore, the allowances should be characterized as a reduction of revenue in Company D’s income statement.

Customer Classification Discussion: The retailers do not have documentation to support the incremental, identifiable nature of the costs incurred to sell Company D’s products and services required by the model in EITF 02-16. Therefore, the payments should be characterized as a reduction of cost of sales when recognized in the retailers’ income statements.

EXAMPLE 2
Facts: Company E provides satellite television services. It sells the hardware (a satellite dish and receivers) necessary to receive its services through retailers that sell the hardware and arrange installation. The hardware is purchased from Company E and retailers receive an advertising allowance of $100 for each receiver sold and activated. That allowance is shown as a deduction on the related invoice. Retailers are required by their contract with Company E to use the advertising allowance to advertise Company E’s products and services and to provide documentation of the expenditures to Company E.

Vendor Classification Discussion: Company E receives an identifiable benefit (advertising) from the retailers that is sufficiently separable from the retailers’ purchases of Company E’s products. Company E could have purchased that advertising from another party that does not purchase Company E’s satellite dishes and receivers. Therefore, the first condition of the EITF 01-9 model is met. As Company E receives documentation of the advertising expenditures, it is likely that it can estimate the fair value of the benefit received based on the prices charged for similar advertising. Thus, the second condition of the EITF 01-9 model would also likely be met. As such, the lesser of the fair value of the advertising and the amount of the allowance would be characterized as an expense. If the amount of the allowance exceeds the fair value of the benefit, that excess would be characterized as a reduction of revenue.

Customer Classification Discussion: The retailers have documentation to support the incremental, identifiable nature of the advertising costs incurred to sell Company D’s products and services as required by the model in EITF 02-16. As such, the lesser of the amount of the payment or the amount of the related advertising costs is recognized as a reduction of advertising expense when recognized in the retailers’ income statements. Any excess of the payment over the amount of the related advertising costs is recognized as a reduction of cost of sales when recognized in the retailers’ income statements.

Slotting Fees and Allowances
The terms “slotting allowances” and “slotting fees” describe a family of practices that involve payments by manufacturers and wholesalers to persuade downstream resellers to stock, display, and support particular products. The amounts and timing of these payments vary wildly, depending on the negotiations between the parties. They are most often charged by grocery retailers who are asked to stock a new product or to devote a certain amount of shelf space to a product or family of products. Slotting fees are increasingly used for other retail products as well, such as computer software, compact discs, books, magazines, apparel, over-the-counter drugs, and tobacco products.

Vendor classification Because of the nature of slotting fees and allowances, it is almost impossible for the first criterion in the EITF 01-9 model to be met. Avendor might argue that a slotting fee gives a type of advertising benefit due to greater awareness of the product. However, even if this were considered an identifiable benefit from a slotting fee, it could not be obtained from any party other than the customer. In certain cases, a slotting fee might provide the vendor with exclusivity in its product category in a particular store. Although exclusivity might be an identifiable benefit, it cannot be obtained from any party other than the customer. As such, the first criterion in the EITF 01-9 model will not be met. In addition, the second criterion in the EITF 01-9 model would be difficult to meet, because of the extreme variation that is seen in slotting fee amounts, and the fact that such payments are never made to parties that are not also customers of the payer.

EXAMPLES: TRADE PROMOTION, SLOTTING FEES, AND COUPON PROGRAMS
Playtex Products Form 10-K—Fiscal Year Ended December 31, 2004 We routinely commit to customer trade promotions and consumer coupon programs that require us to estimate and accrue the ultimate costs of such programs. Customer trade promotions include introductory marketing funds (slotting fees), cooperative marketing programs, shelf price reductions on our products, advantageous end of aisle or in-store displays, graphics, and other trade promotion activities conducted by the customer. We accrue a liability at the end of each period for the estimated expenses incurred, but unpaid, for these programs. Costs of trade promotions, cash discounts offered to the trade as a payment incentive and consumer coupons are recorded as a reduction of net sales.

As part of a review of the classification of certain expenses, in the second quarter of 2004, we reclassified cash discount expense as a reduction of revenue. Previously, this expense was included in SG&A. This reclassification amounted to $13.8 million in fiscal 2003 and $15.5 million in fiscal 2002. While this discount is a payment incentive, we are now including this with other trade incentives previously reported as a reduction to net sales by employing a broader definition of the Emerging Issues Task Force (“EITF ”) No. 01-9, “Accounting for Consideration Given By a Vendor to a Customer (Including a Reseller of the Vendor’s Products).”

Rayovac Corp. (Spectrum Brands) Form 10-K—Fiscal Year Ended September 30, 2004
The Company also enters into various contractual arrangements, primarily with retail customers, which require the Company to make upfront cash, or “slotting” payments, to secure the right to distribute through such customer. The Company capitalizes slotting payments, provided the payments are supported by a time or volume based contractual arrangement with the retailer, and will amortize the associated payment over the appropriate time or volume based term of the contractual arrangement. The amortization of the slotting payment is treated as a reduction in net sales and the corresponding asset is included in Deferred Charges and Other in the Consolidated Balance Sheets.

Customer classification Because of the nature of slotting fees and allowances, it would be virtually impossible for a customer to support that it is either providing an identifiable benefit to the vendor or that it is incurring an incremental, identifiable cost related to selling the vendor’s products or services as required by the model in EITF 02-16. The customer would most likely not be able to prove that it could enter into an exchange transaction that has the same terms as a slotting fee arrangement with any parties other than its vendors. In addition, the cost of the space provided by the customer to the vendor in a slotting fee arrangement would not be considered an incremental, identifiable cost. As such, slotting fees and allowances should nearly always be treated as reductions of cost of sales when recognized in the income statement.

Some people have argued that slotting fees should be accounted for as a cost incurred by a vendor to lease shelf space from a retailer. While certain slotting fee arrangements are indeed written in the form of a lease, slotting fee arrangements generally do not provide the vendor/lessee with the right to access and use the shelves for a specified period of time. Instead, the shelf space continues to be controlled by the retailer. In addition, in a true lease, the products on the shelf would be those owned by the vendor/lessee, as the lessee would be in control of the space, and the receipts from the sale of those products would belong to the vendor/lessee. However, in a slotting arrangement, proceeds from the sale of products off the shelves are the retailer’s revenues. For these reasons, a slotting fee arrangement does not meet the definition of a lease from an accounting standpoint, even if its legal form appears to be a lease.

OBSERVATION: Certain stores do indeed lease a portion of the store to a provider of products. However, in those situations, the store receives only lease revenue, not the revenue from the sale of products, and the lessee of the portion of the store subject to the lease controls the products in that portion of the store (see “Leased Departments” earlier in this chapter). Therefore, those arrangements are not similar to slotting fee arrangements.

Coupons and Rebates
Coupons and rebates intended to be redeemed by consumers are the most widely used form of sales incentive. This category of incentive includes newspaper and direct mail coupons, as well as rebate forms included with various products. In some cases, the coupon or rebate is offered by a retailer that deals directly with the consumer, while in others, the offer is made by a product manufacturer to the end consumer, even though the consumer purchases the product through a retail reseller.

Vendor classification Coupon or rebate offers are often part of promotions instituted and run by companies’ marketing departments and are considered part of the marketing budget. Because of that, in the absence of any accounting literature, many vendors reported the costs of the discounts as a marketing expense, recording revenue for the normal selling price of the related products or services. However, based on the model in EITF 01-9, coupons and rebates would always need to be characterized as a reduction of revenue, since there is no separately identifiable benefit received by the vendor.

EXAMPLE: CLASSIFICATION OF COUPONS
Revlon Consumer Products Corporation Form 10-K—Fiscal Year Ended December 31, 2004
Net sales is comprised of gross revenues less expected returns, trade discounts and customer allowances, which include costs associated with offinvoice mark-downs and other price reductions, as well as coupons. These incentive costs are recognized at the later of the date on which the Company recognizes the related revenue or the date on which the Company offers the incentive.

Customer classification Regardless of whether the consumer presents the coupon or rebate to the vendor or a retailer for redemption, the consumer should treat the cash payment received from the vendor, or the redemption value provided by the reseller, as a reduction of cost of sales based on the model in EITF 02-16. This is due to the fact that the consumer is not providing any products or services to the vendor in return for the payment and the fact that the payment does not relate to reimbursement of any particular cost. If a reseller is involved in redeeming the coupon, the reseller’s treatment of the reimbursement from the vendor depends on whether the coupon or rebate possesses the characteristics discussed earlier under “Vendor’s Sales Incentives Offered Directly to Consumers.” If the coupon or rebate does possess these characteristics, the retailer would account for the coupon or rebate on its balance sheet. In other words, the model in EITF 02-16 would not apply to the retailer and the retailer would not reflect the reimbursement from the vendor in its income statement. If the coupon or rebate does not possess these characteristics, the model in EITF 02-16 would apply to the retailer. Applying the model in EITF 02-16 to a coupon or rebate lacking one or more of these characteristics would result in the payment from the vendor to the retailer being classified as a reduction in cost of sales.

In many cases, the retailer receives a “fee” for redeeming coupons. That fee should be analyzed in the context of the model in EITF 02-16 to determine whether it should be recognized as revenue, a cost of sales reduction, or a reduction of another cost. Generally, the analysis of this “fee” under EITF 02-16 would result in it being recognized as a cost of sales reduction since (a) the related activity does not provide an identifiable benefit to the vendor as defined in EITF 02-16 and (b) the customer has not incurred an incremental, identifiable cost related to that activity.

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Copyright 2006 CCH Publishing, a WoltersKluwer business. Excerpted by permission.