Re: Proposed changes to make it easier to ship after billing

On Mon, May 27, 2013 at 6:16 AM, Brian Wolf <..hidden..> wrote:

Both Chris and Erik have made good points regarding the accounting aspect of this issue.

Can someone clarify:
Does the product transfer ownership to the customer when it is shipped, or when received?

This depends on who accepts risks of damage during shipment and what your obligations are post-shipping. If the customer does, and if returns are immaterial (not common enough to count and the goods can simply be resold without much in the way of additional costs), then you could invoice as of the shipping day.

Those points in time may be days apart. Is income recognized when shipped, or once the product (or service) is complete? For example, if a customer buys a new workstation (or some other equipment), maybe the "package" is complete once it arrives and you provide some phone support for setup.

Might be worth getting into just a little detail here. Apologies if it is too much detail.

Ok, starting with income (and then getting to expenses which are significantly more complex):

If it is only a few days, and you don't have unusual activity around the end of the year, that's probably not material to and you can do what you want. The larger issue though is what happens when it is unexpectedly delayed. Maybe you invoice for the workstation and then have to backorder it. Now you have what may go from a few days to possibly a couple weeks. Or suppose it has to be cancelled. These get messy. In general I think it is easier to post late and adjust backwards for reporting than to deal with the complexities of what can happen when you invoice early.

If the customer is responsible for it as soon as it leaves your shop, or if you take into account any likely returns, you can recognize income as soon as you ship. (If there are insignificant returns, you don't have to track them as they aren't material).

Now, it gets more complex than a specific date because some packages could be transferred over a period of time. For example, if you sell hosting, and someone prepays for a year, you could book the income as "unearned income" and adjust it to actual income, or you could book as income and adjust backward.

So if I pay $80 for a year of hosting on October 1, you would materialize $20 in income on that year, and $60 the next year. Most of the time this is not really material but there are cases when it could be, since recognizing all income at the beginning of the contract can inflate earnings when clients are gained and inflate losses when customers

cancelled.

Now, why is this important? One of the major goals of accrual-basis accounting is to match income and expenses. This means that the related expenses don't post until the income is materialized. Income isn't materialized until it is "earned" in the sense of goods and services delivered.

What this means, essentially, is that a payment up front is handled very differently accounting-wise than a payment in arrears. A payment up front is an increase of an asset and a liability. A payment in arrears ins an increase in asset and income (with related expenses).

So that's the accounting end of it.

What we'd like to eventually do is specify a date range over which an invoice or other financial document takes effect. so that all the mechanics of this can be handled automatically. We would also like to have much better handling of prepayments in relation to orders, before invoices are posted to the books. You can kind of do that today using the depreciation interface but it is not really ideal.

Best Wishes,

Chris Travers