Revenue at gross or net
/When to Record Revenue at Gross or Net
Recording revenue at gross means that you record the revenue from a sale transaction on the income statement. Recording revenue at net usually means that you’re only recording a commission on a sale transaction as the entire amount of revenue. If there isn’t strictly a commission, you can still report revenue at net by netting the amount billed to the customer against the amount paid to the supplier.
There are many situations that fall into a gray area where revenue could be reportable at gross or it could be reportable at net. This is a major issue for a business, which will probably want to record revenues at gross in order to give the appearance of a larger entity, especially if it is about to be sold to an acquirer that will pay more based on the sales volume of the business.
Guidelines for Reporting Revenue at Gross
The Emerging Issue Task Force (EITF) set up a number of guidelines for the correct treatment of revenue in their issue number 99-19, "Reporting Revenue Gross as a Principal Versus Net as an Agent.” Please note that these are guidelines, so recording at gross or net is a matter of judgment. The guidelines that point you in the direction of reporting revenues at gross are:
You are the primary obligor in the sale transaction. This means, are you responsible for providing the product or service, or is the supplier? If you’re doing the work or shipping the product, you can probably record at gross.
You have general inventory risk. If you take title to the inventory before you sell it to the customer, and you take title to any returns from customers, you can probably record revenue at gross.
You can select suppliers. This one is important, since it implies that there isn’t some key supplier operating in the background who’s actually running the transaction.
You have credit risk. This means that if the customer does not pay, then you absorb the loss, and not a supplier. However, if you’re only at risk for losing a commission if the customer doesn’t pay, then you’re probably looking at recording the revenue at net.
If you get to set the price, then you probably have control over the entire transaction, and you can record the revenue at gross.
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Guidelines for Reporting Revenue at Net
The EITF also created several guidelines that point you in the direction of reporting revenues at net. They are as follows:
The amount you earn is fixed. This indicates a commission structure, which is sometimes set up as a fixed payment per customer transaction. If you earn a percentage of what the customer pays, this is also an indicator that you report revenue at net. In either case, you’re really just an agent for someone else.
The other two guidelines for reporting at net are just the reverse side of some earlier guidelines. If a supplier has credit risk, or if a supplier is responsible for providing products or services to the customer, then you’re probably looking at reporting revenue at net.
For most companies, you can pretty easily pick which guidelines apply to you, and in most cases you probably record your revenue at gross. But here are some considerations to think about:
You run an Internet store, and you collect money from customers, and then instruct a supplier to ship the goods to the customer. In this case, you have credit risk, so there’s an indication that you can probably record revenue at gross. And in fact, most Internet stores do. But what if there’s also a statement on the website that the website operator only accepts orders on behalf of suppliers, and the operator is not responsible for any problems with shipments? Chances are, you’re now looking at net revenue reporting.
You develop specifications for custom products with the customer, and then you find a supplier who can make it. In this case, you can record revenue at gross, because you have credit risk and you get to pick the supplier.
You’re a travel discounter, and you negotiate with the airlines for reduced prices. You then advertise the reduced rates to the public. You bill the customer, and you’re responsible for delivering the ticket to the customer. But – once the customer receives the ticket, the airline is responsible for all subsequent service. There’s no inventory risk and the primary obligor is the airline, which points you toward net reporting. On the other hand, you can set the price and you bear the credit risk, which tends to point toward gross reporting. The EITF says that the primary obligor issue in this example overrides the other factors, and that one points you in the direction of reporting at net.
Finally, consider again that the EITF has only issued guidelines, from which you have to make a judgment regarding whether to report at gross or net. It is possible that you could have two companies in the same industry with identical business models, and one records revenue at gross and the other at net – and they may both be able to justify their positions to their auditors. Consequently, this is one of those odd topics that can go in either direction.