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Financial Statement Presentation

Companies with Both Gross and Net Transactions

When a company records some transactions as gross and others as net, it may be necessary to separately report revenue from gross reported transactions and revenue from net-reported transactions, and to break out cost of sales in a similar fashion. This allows readers of the financial statements to properly evaluate gross margins on the two types of transactions.

In addition, SEC registrants are required to separately report revenue from the sale of products and revenue from the provision of services (REG S-X, Rule 5-03(b)(1)). Because commissions and fees earned from activities reported net are service revenues, this may often have the effect of requiring separate presentation of revenues from transactions reported gross (product revenues) and revenues from transactions reported net (service revenues).

Disclosure of Gross Activity for Transactions Reported Net The EITF noted that although such disclosures are not required by GAAP, the disclosure of gross transaction volume for those revenues reported net may be useful to financial statement users. However, if the gross amounts are disclosed, they should not be disclosed in any way that appears to characterize them as revenues. In addition, the presentation should not result in the gross activity being presented in the income statement such that it begins a column that sums to net income or loss (EITF 99-19, par. 20).

Leased Departments

Department stores and certain other retailers customarily lease portions of their store space to companies that specialize in certain areas. For example, many higher-end department stores lease space to companies that specialize in displaying and selling cosmetics, or designing and selling wedding dresses. Smaller stores may allow vending machines owned by another party to be placed in various spots around the store. In these situations, the store is essentially leasing space to the companies that run the specialized departments. In return, the store typically receives a lease payment from the other company, and the revenue from the outsourced part of the store goes to the company to whom the operations have been outsourced. That company is also responsible for the costs of running the leased department.

Because the store/lessor in these arrangements has virtually no involvement in the product purchasing, pricing, or sales, these types of arrangements would generally indicate that the lessee company that runs the department should record the sales of that department on a gross basis, with the store recording only its net lease payment as revenue. Furthermore, these types of arrangements generally meet the definition of a lease, and are therefore within the scope of FAS-13. Accordingly, it would be inappropriate for a department store or other retailer to include the sales of the licensed departments in its own revenue figures. Rather, the department store or other retailer should include only the rental income, if the arrangement is a lease, or service revenue, if the arrangement is not a lease, as part of its revenues (SABTopic 8A).

ILLUSTRATION: ASSESSMENT OF GROSS VERSUS NET REPORTING INDICATORS

EXAMPLE 1

Facts: Company A runs a catalog business selling home products, such as rugs, sheets, towels, etc. Company A does not manufacture any of the products it sells, but instead has compiled products from various manufacturers in its catalog. Each product in the catalog identifies its unique supplier, as the identity of the supplier is a factor that customers use in determining whether and which products to order.

Company A maintains no inventories of products, but does take title to the products ordered by customers at the point of shipment from suppliers. Title is passed to the customer upon delivery. The gross sales price is charged to the customer’s credit card prior to shipment and Company A is the merchant of record. Company A must pay its suppliers even if the credit card charge cannot be collected. Suppliers set product sales prices, and Company A retains a fixed percentage of the sales price and remits the balance to the supplier. The catalog and the sales contracts clearly indicate that Company A takes no responsibility for the quality or safety of the products, and that the customer must contact the supplier directly regarding complaints, warranty issues, and returns.

Discussion: Certain indicators point toward gross reporting, while other indicators point toward net reporting. Although indicators of gross reporting exist for physical loss inventory risk (during shipping) and credit risk (for collecting amounts charged to credit cards), those indicators are not sufficient to overcome the stronger indicators that revenues should be reported net. The indicators of net reporting include the fact that the supplier, not the company, is the primary obligor and the fact that the amount earned by the company is a fixed percentage of the sales price.

EXAMPLE 2

Facts: Same as in Example 1, except that (1) Company A sets product sales prices, and therefore earns as a profit any amounts it sells the products for in excess of its agreed-upon purchase price with the supplier, and (2) while Company A still provides no warranty on the products it sells, it does provide a “Satisfaction Guaranteed or Your Money Back” right of return on all products it sells, even when it has no similar right of return with its suppliers.

Discussion: Again, certain indicators point toward gross reporting, while other indicators point toward net reporting. In addition to physical loss inventory risk (during shipping) and credit risk (for collecting amounts charged to credit cards) that are present in Example 1, other gross indicators include both back-end general inventory risk and pricing latitude resting with Company A. In addition, the provisions of the right of return make it less clear as to who the primary obligor in the arrangement is. Therefore, gross reporting is appropriate for Company A.

EXAMPLE 3

Facts: Company B is a travel consolidator that negotiates with major airlines to obtain access to airline tickets at reduced rates that are not available to travelers who buy tickets directly from the airlines. Company B determines the prices at which it will sell the airline tickets. The reduced rate paid to an airline by Company B for each ticket sale is negotiated and agreed to in advance, and Company B agrees to buy a specific number of tickets for specific flights.

Company B must pay for those tickets regardless of whether it is able to resell them. Customers pay for airline tickets using credit cards, and Company B is the merchant of record. Although credit card charges are pre-authorized, there are occasional losses as a result of disputed charges that Company B bears the risk of. Company B utilizes electronic ticketing, and therefore, there is no physical loss risk. Company B facilitates resolutions of complaints by its customers if the customer is dissatisfied with the airline, but Company B’s responsibility ends at successfully booking the reservation; the airline is responsible for fulfilling all obligations associated with the ticket.

Discussion: Company B should use gross reporting for the revenue from the sale of tickets. Company B has general inventory risk, a strong indicator of gross reporting, because it commits to purchasing tickets before it resells them. Ticket pricing also points to gross reporting as Company B has complete latitude to set sales prices for tickets and, as a result, the amount it earns will vary.

In addition, Company B has credit risk for collecting customer credit card charges, although a weak indicator of gross reporting. An indicator of net reporting also exists in that the airlines are the primary obligors, as they provide the air travel transportation. However, the gross reporting indicators in this case outweigh the fact that the supplier is the primary obligor.

EXAMPLE 4

Facts: Same as Example 3, except that Company B is only required to pay for tickets that it resells to customers.

Discussion: Company B should report revenues net. As in Example 3, the fact that the airline is the primary obligor is a strong indicator of net reporting. There are two indicators of gross reporting (pricing latitude and credit risk). However, these indicators do not overcome the strong net indicator relating to the supplier being the primary obligor. The strong indicator of gross reporting, general inventory risk, that was present in Example 3, is not present here.

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