FASB

FASB Ruling 01-9:
Bigger Than It Looked

By Bob Houk

Reprinted with permission from Outlook Magazine. Bob Houk is with CoAMS, Inc., a Chicago-based firm specializing in trade promotion management, consulting, services, and software.

The Financial Accounting Standards Board last year released a ruling by the Emerging Issues Task Force – designated innocuously as 01-9. The ruling, to the extent that it garnered any attention at all, was described as requiring consumer packaged goods companies to report their payments for slotting fees as reductions in revenue rather than as marketing expenses.

Since many CPG companies spend a lot of money on slotting, this was understood to be of some significance within that category, but few companies outside that arena paid much attention.

A closer look at 01-9 indicates that its scope goes far beyond slotting and far beyond CPG.

The Real 01-9

An examination of the FASB document indicates that all trade payments must be classified as revenue reductions unless it meets all of the following conditions:

The payment covers a service by the retailer that offers a clear benefit to the manufacturer,
The benefit is clearly separable from the sale of the product,
The benefit could be purchased from a source other than the retailer, and,
The manufacturer obtains proof of performance and can reasonably estimate true costs.

For the sake of simplicity, we refer here to “retailer” and “manufacturer”, but it could involve any players in the distribution channel making and receiving such payments.

What It Covers

The document also makes clear that payments not to the retailer are included, offering rebates and coupons as examples.

Other examples cited as revenue reductions include end caps, floor planning, and salaries – either because they are inseparable from the sale of the product, and/or because they are services that could not logically be performed by a provider other than the retailer.

In fact, with the exception of one somewhat unusual case involving fixtures, all of the fifteen examples cited, other than those dealing with advertising, were considered revenue reductions.

Expenses

The FASB examples indicated that traditional co-op advertising, such as newspaper circulars in which a retailer advertises the manufacturer’s product, could still be classed as a marketing expense, since the manufacturer receives a benefit from it, and could buy comparable advertising elsewhere (i.e., could buy ad space directly from the newspaper).

But even here, there are some caveats.

Such promotion, it was ruled, could be classified as an expense only if the performance of the service was documented. In practice, although Federal Trade Commission guidelines have always required such documentation, many manufacturers have long given up on getting their largest retailers to submit it.

The FASB cited an example in which a manufacturer provides an off-invoice allowance to the retailer, with the understanding that the retailer will use the allowance to advertise the product – but the retailer is not required to document the advertising. The board concludes that this would not be allowable as an expense and must be classed as a revenue reduction.

The FASB also says that the manufacturer must be able to make a reasonable, objective estimate of the cost of the service. Large stores, of course, are even less likely to provide cost documentation than proof of performance. It should be noted, though, that the means exist to make reasonable estimates of costs where documentation is lacking – for example checking newspaper rate cards and printing-cost guidelines.

The cost question raises another concern for manufacturers who work with major retailers. Most have known all along that they are overpaying for the cost of such things as space in a circular. According to the FASB, a manufacturer who pays $50,000 to be in a circular, getting space that is objectively worth perhaps $20,000, must classify the other $30,000 as a revenue reduction.

What is not yet clear is what cost comparisons could be used. Clearly, newspaper rate cards or printing-cost guidelines would suffice. But might a manufacturer reasonably use rates paid to the same or similar retailers by other manufacturers? Assuming of course that such comparables could be obtained.

What It Means

The implications of this are, obviously, huge. In CPG, it is not unusual for manufacturers to have trade promotion budgets that run as high as 15%-20% of sales. The consequences in terms of revenue could therefore be in the hundreds of millions or even billions for the largest CPG companies. Even in other merchandise categories it is not unusual to have trade promotion expenditures of 5%-10%. It is likely that the total amount expended on trade promotion in the US is in the $100b-$150b range (though much of this is for advertising or other “benefit” items that could be classed as marketing expenses if they can be documented).

A consequence being felt in many companies is an inability to make sales quotas. If a salesperson has been assigned a quota based on a 5% increase from last year’s figures, without adjusting for a 10% revenue reduction, s/he is in reality being expected to generate a 15%+ sales gain. This is being reported by some companies.

First, please note that these opinions are preliminary, and that much remains to be learned about this subject. The first recommendation, therefore, is that you consult with your auditors and review your practices and procedures.

Additional steps we recommend would be to initiate documentation and cost auditing procedures for payments that would qualify as marketing expenses. Most companies had such procedures until a few years ago.

We recommend that you then re-examine your trade allowance programs and move more of your trade spending to the funding of activities that qualify as marketing expenses. In addition to helping your revenue figures, this should also benefit your brand by providing it more promotion and reducing price-cutting.

And finally, this is an opportunity to examine the allowances that you are providing and to recognize the true pricing you are giving to, and the profit you are making on, your major accounts.

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Updated as of 09/01/2006