Recording Reimbursed Expenses as Revenue (#96)
/In this podcast episode, we discuss how to record expenses that are to be reimbursed by the customer. Key points made are noted below.
Reasons Why Reimbursed Expenses are Recorded as Revenue
This issue was addressed by a group called the Emerging Issues Task Force, or EITF. The EITF passes judgment on smaller technical topics, and generally they do quite a good job of it. But on this one, I wonder if they were passing around the bottle during their discussions. And – by the way, one of my co-authors claims that the Accounting Standard Board actually had a pony keg in one of their meetings, and that might explain some of the accounting standards.
But anyways, the EITF came up with a pronouncement called EITF Issue number 01-14. The title is “Income Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses Incurred.” I think they designed the title to put you to sleep, so they could slide the contents right on by. If this thing was an infomercial, they would have called it something like “Easy Way to Overstate Revenue – Operators are standing by.”
So, what the EITF said was that out-of-pocket expenses are things like travel and entertainment and photocopying charges. Sometimes, customers agree to reimburse the company for these expenses. The question the EITF addressed was whether you treat these customer payments as revenue or as a reduction of the underlying expense.
Their conclusion was that you report the payments as revenue. Ouch. The main reason they gave for doing this was that customer payments for shipping and handling costs are already treated as revenue, and this is basically the same sort of thing.
The EITF also stated that this makes sense, because the buyer is benefiting from the expenditures, rather than the seller. Also, the seller has credit risk, because it receives reimbursement from the buyer after it paid for the expenditures. And to be fair to the EITF, they made one of those “on the other hand” points, which was that the company is earning no profit on these expenses, and that tends to point toward treating them as an expense reduction rather than as revenue. Despite that, though, the EITF came down on the side of recording reimbursed out-of-pocket expenses as revenue, and so that it what you’re supposed to do.
Reasons Why We Should Not Do This
Now, as you can probably tell, I’ve been busy sharpening the knives on this one. I’m not going to tell you to handle this differently, but I will point out some holes in the argument.
First, when I’m going through a due diligence analysis on a possible acquisition, one of the first things I do is see if they have any reimbursed out-of-pocket expenses, and strip that number out of revenue. The reason is that it skews the results of the company to make it look like it’s doing more business than it really is. This is really critical if you’re buying a company based on a multiple of its revenues. I don’t advocate buying a company based on that type of valuation, but some people do, and this issue causes them to overpay. So right there, you know something is wrong when people are deliberately stripping out that figure – it’s a clear revenue overstatement.
My second point is theoretical, which is that revenue should reflect the revenue-generating activities of the company, like providing consulting services or shipping a product. Being reimbursed for out-of-pocket expenses is not a revenue generating activity. It simply means that either entity could have paid for the expense up front, and it happens to have been more convenient for the seller to do it. So, consider a situation where the buyer gives its corporate credit card to the seller, and it tells the seller to use the card to pay for all of those out-of-pocket expenses. Now the expenditure path goes completely around the seller, and the buyer pays. The seller records no expense, and no revenue. You get the same result in your accounting records if you use the seller’s reimbursement payment to simply offset those expenses in your records, which flushes out the expense. But you’re not allowed to do that.
Now all of this may seem like a lot of arguing over nothing, since the seller records no change in profit no matter how you handle out-of-pocket reimbursements – only the revenue and offsetting expense figures are impacted. Nonetheless, it can give the impression of a business being larger than it really is.