Customer acceptance uncertainty

The Securities and Exchange Commission (SEC) is quite conservative in how it allows publicly held companies to recognize revenue, especially in situations where it is unclear whether customers will accept delivered goods and services. In essence, the SEC does not approve of revenue recognition until the uncertainty surrounding customer acceptance has been resolved. This means that revenue recognition may be predicated on the exact wording of sale agreements, where customers are allowed to withhold their approval subject to testing and other criteria.

When there are customer acceptance criteria in a sales agreement, these are assumed by the SEC to be significant clauses that cannot be ignored. Consequently, revenue recognition is prohibited until formal acceptance by the customer has occurred or the terms of these clauses have lapsed. Acceptance provisions usually fall into one of the following categories:

  • Evaluation. The customer has accepted delivery only to evaluate the goods, so that the seller retains title during the evaluation period. The customer then confirms that it wants to buy the goods at the end of the evaluation period.
  • Return. The customer can return the goods at its discretion. The seller can recognize revenue, but only if it can make a reasonable estimate of future returns, for which it recognizes an allowance for doubtful accounts. Otherwise, the seller must hold off on recognizing revenue until the buyer's right of return has lapsed.
  • Match to specifications. The customer can return the goods if they do not meet required specifications. If the seller can prove that the goods already meet these specifications, it can recognize revenue at the point of sale, as long as it can also set up a warranty reserve for any reasonably estimated return amounts. If the seller cannot prove that its products meet the customer's specifications, it must wait to recognize revenue until the customer has accepted the goods.
  • Match to customer criteria. The customer can return the goods if they do not meet criteria specified by the customer. In this case, it is easiest to wait for formal customer approval before recognizing the related revenue. It may be possible to prove acceptance by testing the goods prior to shipment, though this may not be sufficient if the seller cannot simulate how the goods will perform once they are integrated into the customer's systems.

Formal documentation of customer acceptance is not necessary if the seller can document other forms of customer acceptance.