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1.5.1 Spare parts

Refer to FSP 8.4.2, FSP 8.6, PPE 1.5.3, and IV 1.5.2 for the accounting for spare parts inventory.

1.5.2 Stores inventories

It is common for manufacturing companies to maintain “stores” items, which are spare maintenance materials and parts kept on hand as backup components of major production lines. These items are considered essential to the operations of the facility. Keeping stores items on site is a significant investment that is made to prevent or limit lost production hours when key parts of the machines fail.
It is appropriate to capitalize stores items because they have a service potential (when a part on a machine breaks down) and will provide future economic benefit to the company. There is no specific authoritative literature regarding stores items.
Refer to FSP 8.6 for discussion of the financial statement presentation of stores items.

1.5.3 Demonstration units

Providing sales representatives and potential customers with demonstration (“demo”) or loaned units (i.e., products/goods that might otherwise be held in inventory for sale) is a common practice among technology companies. These units typically remain with the customer for a period of time before sale to the customer or return to the company for refurbishment. Demonstration units are classified as inventory or fixed assets depending on a number of factors, including the nature of the product, the length of time the units remain in the field prior to being sold, and whether it is management's intent to sell the units. The longer the unit remains in the field before being sold, the more likely it is that the equipment is a productive asset of the company and should be classified as a fixed asset and depreciated down to its estimated recoverable value over its estimated useful life. Units that remain in the field for a relatively short period prior to sale are generally classified as inventory on consignment. Additionally, equipment that can be readily repaired or restored is more likely to be inventory than is a product that cannot. The need for a reserve for estimated costs to refurbish the inventory or to write the units down to net realizable value as a result of technological advances should be considered (see IV 1.3.2). In addition, on occasion, demonstration units may be provided to customers as a sales incentive (see IV 1.5.5).

1.5.4 Vendor rebates

ASC 705-20 provides accounting guidance on how a customer (including a reseller) of a vendor's products should account for cash consideration (as well as sales incentives) received from a vendor. Under the provisions of ASC 705-20-25-1, cash consideration received by a customer from a vendor is a reduction of the price of the vendor's products or services. Such payments should, therefore, be characterized as a reduction of cost of sales when recognized in the customer's income statement, unless the consideration is either a payment for distinct goods or services transferred to the vendor, a reimbursement of costs incurred by the customer to sell the vendor's products, or a payment for sales incentives offered to customers by manufacturers. Additionally, a rebate or refund, payable if a customer completes a specified cumulative level of purchases or remains a customer for a specified time period, should be recognized as a reduction of the cost of the vendor’s products based on a systematic and rational allocation as a customer earns the rebate or refund, so long as the amounts to be earned are probable and reasonably estimable.
Depending on a company’s level of inventory, frequency of inventory turns, and inventory costing methods used, cash consideration from a vendor may be required to be accounted for as a reduction of the price of a vendor’s product and, therefore, such consideration should be considered when determining the cost of a company’s inventory. ASC 705-20-25-10 through ASC 705-20-25-12 also indicates that rebates or refunds that are probable and estimable should be considered in valuing inventory. In addition, for companies that use the LIFO method for valuing inventory, cash consideration from a vendor required to be included as a reduction of the price of the vendor’s products should be considered part of the cost of current year purchases and may require special consideration when valuing LIFO increments. See IV 3 for additional guidance on valuing LIFO increments.

1.5.5 Vendor incentives offered to reseller’s customers

ASC 705-20-25-4 through ASC 705-20-25-9 provides accounting guidance on a reseller's characterization of sales incentives offered to consumers or other end users by manufacturers (i.e., manufacturers' coupons and other vendor-specific coupons). The guidance provides that consideration received by a reseller from the vendor in exchange for a vendor incentive tendered by a consumer (e.g., a manufacturer's coupon) should not be reported as a reduction of the cost of the reseller’s purchases from the vendor, provided that the vendor incentive offered directly to consumers has the following characteristics:
  • It can be tendered by a consumer at any reseller in partial payment of the price charged by the reseller
  • The reseller receives a direct reimbursement from the vendor based on the face amount of the incentive
  • It is not part of any broader vendor-reseller incentive program or cooperative promotional program
  • An agency relationship with respect to the incentive exists between the vendor and reseller, whether expressed or implied

If the consideration received has these characteristics, it would be characterized as revenue (or other income, as appropriate) and accounted for in accordance with ASC 705-20-25-4 through ASC 705-20-25-12, as applicable. Refer to RR 4.2 for additional considerations on determining the transaction price.
All other consideration received by a reseller from a vendor is subject to the guidance in ASC 705-20. See IV 1.5.4 for additional details.

1.5.6 Vendor allowances

Vendor allowances for construction of fixed assets by the retailer should be evaluated under ASC 705‑20-25 to determine the appropriate accounting. Under ASC 705‑20-25-1 through ASC 705‑20-25-3, unless certain conditions for the use of the cash are defined, cash consideration received by a retailer from a vendor is presumed to be a reduction of the prices of the vendor's products and thus a reduction in inventoriable costs. If the cash consideration is used for a specific purpose as determined by the vendor (e.g., advertising), it may be appropriate for the retailer to apply the consideration as a reduction of expenses for advertising as noted in ASC 720-35.

1.5.7 Cost of goods sold

There is diversity in practice as to the types of costs companies include in cost of goods sold when those costs are not directly assignable to the inventory purchased. In addition to the allocation of merchandise-related costs (e.g., freight, duty, broker fees, import rights), many companies include other costs incurred in the process of acquiring inventory and making it ready for sale. These expenses may include buying, occupancy, warehouse, and distribution and delivery expenses. Although these expenses may be classified as cost of goods sold, they do not necessarily flow through inventory. ASC 330-10-30-7, addressing the initial measurement of inventory, excludes abnormal freight, handling, and amounts of wasted materials (spoilage) from the inventory cost pool to be capitalized. Fixed overhead costs for a normal capacity level should be considered for capitalization.
The classification of expenses as cost of goods sold will depend upon their nature and upon the accounting policies followed by the company. The practice of including significant amounts of non-merchandise costs in cost of goods sold should be disclosed by the company in the notes to the financial statements.

1.5.8 Merchandise purchase order terms

Purchase order terms and procurement contracts generally include provisions related to taxes, duties, cash payment terms, insurance, rights of inspection and return, and terms relevant to the vendor’s revenue recognition. Often additional brokers, buying agents, quota holders, or others may have rights and duties along the supply chain. Entities often record inventory at the earlier of (1) the time of receipt, (2) receipt of invoice, or (3) payment, but entities should consider contractual terms that may require the recognition of inventory at an earlier date, based on when control is obtained. Some vendors have negotiated with companies to have specific transfer of title terms (e.g., FOB shipping point) or other indicators of control to clarify the vendor’s revenue recognition. Shipping terms generally specify when title transfers and are a trigger for the entity’s legal obligation to pay for the goods. Therefore, terms such as FOB shipping point may indicate control has been obtained and require the entity to recognize the in-transit inventory.
Entities may utilize letters of credit for overseas purchases. The shipping and payment terms of these letters may vary, which could result in different accounting conclusions as it relates to the timing of recording inventory purchases. 
See IV 1.2 for further discussion of transfer of control.

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