Finance

Year End Revenue Recognition and Accrued Rebates

David Hunt
Updated:
February 23, 2024

How was your last year end? We're not referring to the actual outcome, but the process of getting your year-end figures together.

If you're in the fortunate position of being able to match each supplier invoice to an order at the right price, then perhaps your year-end revenue recognition is simply a question of dealing with a volume of transactions?  But for those in the building supplies sector, those working in buying groups, and many wholesale distribution companies, revenue recognition is hampered by supplier rebates, retrospective discounts and other promotions.

In fact, in industries where rebates are an important part of normal trading, the rebate accountant is often the key to having a true picture of your profits and losses.

Let's Talk About Accrued Rebates

What is a Rebate Accrual?

With rebate deals, it is common to earn rebates at a different rate to which you receive them. The rebate accrual is the amount of rebate that has been earnt, but not yet received (or for customer rebates, the amount that is owed but not yet paid).

For example, you may earn a quarterly rebate based on overall spend with a given supplier, but that supplier might only pay that rebate at the end of the year. From an accounting perspective, this rebate income needs to be represented, or ‘accrued’ for, at the time the rebate is earnt, not the time it is received.

This is a problem for merchants and distributors where their profit margin relies heavily on rebates. If profit and loss statements are based only on cash in the bank, then profits will appear far less than reality until the receipt of the final rebate payment. The same can be said for suppliers, where profits would appear far higher until the previously unaccounted for rebate payments were made at the end of the trading period.

Accurately forecasting sales, purchases and their associated revenue is vital to the accurate calculation of accruals -- and, ultimately, profit and loss. Organizations must have complete confidence in their rebate accruals process, and develop a structured and rules-based approach to rebate accounting, forecasting rebate revenue, and creating a clear audit trail that fully justifies accrual decisions.

What is an Over Accrual?

When a company overestimates the amount of rebates it expects to pay out in a given period, it creates an over accrual. This means that the company sets aside too much money to cover these rebates, leading to an inflated liability on its books. Consequently, its expenses appear higher than they should be, reducing the reported profit for that period.

For instance:

Suppose a company overestimates its rebate obligations by $100,000 in January. In February, when the overestimated rebates are not paid out, the reported expenses will be lower by $100,000, artificially inflating the profit for February.

An over accrual of rebates can signal to auditors that the company's accounting department may need to refine its processes. Accurate forecasting of rebates is crucial for maintaining the integrity of financial statements and ensuring transparency for stakeholders.

To prevent over accruals, it's prudent to only make accrual entries when the amount to be recorded is readily calculable. If there's uncertainty or fluctuation in the amount, it's advisable to err on the side of caution and record the most conservative figure.

What is an Under Accrual?

An under accrual occurs when the estimated amount of a rebate accrual journal entry falls short. Consequently, an under accrual of a rebate boosts profit for the recording period, whereas an under accrual of rebate revenue reduces it.

Accruals are typically set up as reversing entries in accounting software. This means the opposite of the original entry is recorded at the start of the next accounting period, effectively neutralizing the impact over two periods. Thus, an under accrual in one period generates the reverse effect in the subsequent period.

For instance:

  • Suppose in April, the company under accrues $3,000 for anticipated rebate expenses.
  • Consequently, in May, the expenses will be understated by $3,000, leading to an overstatement of profits for that period.

Auditors closely scrutinize such situations to ensure that expenses are accurately recorded, as failure to do so can artificially inflate profits, potentially misleading stakeholders.

The Dangers of Poor Accounting for Rebate Accruals

Of course, there are very serious consequences if rebates are mishandled, and profits are over or under-stated. If companies don't account enough money to pay upcoming expenses, they're often faced with a last-minute challenge to reallocate funds and cover unexpected claims. Worse yet, in some extreme cases, under-accruing can force organizations to restate their earnings, seriously impacting corporate value.

Several companies have hit the headlines because they've improperly accounted for rebates and, as a result, overstated profits. Tesco is probably the most famous in the UK, where profits were overstated by over £250m and the Serious Fraud Office was brought in to investigate.

Monsanto, the suppliers of the popular weedkiller -- Roundup, were given an $80m penalty after it allegedly misstated its earnings, owing to problems with rebate accounting in France, Germany and Canada. It is reported that payments made to distributors were recorded as selling, general and administrative expenses, rather than rebates, which increased gross profits from Roundup in those countries.

IFRS has landed

How IFRS 15 has Changed Accounting for Accrued Rebates

In 2018 a new standard, IFRS 15 came into effect published by the International Accounting Standards Board. This forced businesses to adhere to strict and harmonised rules for revenue recognition, and fuller disclosure on their financial statements — especially those that have to account for rebates, discounts and incentives.

That ability to record and track all aspects of a rebate agreement, from the details of a deal to the claims processing and financial reporting, is now under more scrutiny than ever. Because of this, more and more companies are starting to look at specialist software like Enable to help ensure both financial compliance and support improved margins.

Challenges for Rebate Accounting Teams

IFRS states that “Where a contract contains elements of variable consideration, the entity will estimate the amount of variable consideration to which it will be entitled under the contract”.

This can be hugely problematic for rebate accountants. Not only do they have to understand and document the agreements that have been made (we recently prised apart a contract that had no less than 300 deals contained within it!), rebate accountants have to work with buyers to understand the probability that its inclusion will not result in a significant revenue reversal in the future when the uncertainty has been subsequently resolved.

It makes perfect business sense to create deals that are geared around influencing behaviour but based on actions, not promises.  The difficulty is that we have to account for those promises (contractual agreements) in some way.

Year-end Revenue Recognition Principles

Year-end revenue recognition refers to the accounting standards that govern when and how a company recognizes revenue in its financial statements at the end of a fiscal year. Revenue recognition is a critical aspect of financial reporting, as it directly impacts a company's performance and profitability.

Year-end revenue recognition can become complicated when dealing with factors such as supplier and customer rebates due to:

  • Contingent nature of rebates
  • Estimation of rebate amounts
  • Timing of recognition
  • Variable considerations
  • Impacts on transaction price
  • Contract modifications

Recording Year-end Revenue Recognition

So, here are a few questions to ask yourself when recording year-end revenue:

       
  •        Did you have clarity on how to show the value of rebates in your accounts?    
    •    
  •        Was it clear what you should accrue for through year-end revenue recognition
    •    
  •        How easy was it to find out which procurement deals had yielded what rebates and are you sure you claimed for everything that you are owed?    
    •    
  •        And how might you improve on that in the future?    

To regain control over accrued rebates, companies must take a hard look at their current rebate accounting processes and if necessary, implement a rebate management solution to address the gaps that some accounting systems leave behind. See how Enable can help you regain control.

Category:
Finance

Contents

Continue Reading

Rebate Types

What is a Rebate Program?

Read more
Rebate Types

What is a Discount?

Read more
Rebate Management

Turning Rebate Risks into Opportunities

Read more
Finance

Year End Revenue Recognition and Accrued Rebates

David Hunt
Updated:
February 23, 2024

How was your last year end? We're not referring to the actual outcome, but the process of getting your year-end figures together.

If you're in the fortunate position of being able to match each supplier invoice to an order at the right price, then perhaps your year-end revenue recognition is simply a question of dealing with a volume of transactions?  But for those in the building supplies sector, those working in buying groups, and many wholesale distribution companies, revenue recognition is hampered by supplier rebates, retrospective discounts and other promotions.

In fact, in industries where rebates are an important part of normal trading, the rebate accountant is often the key to having a true picture of your profits and losses.

Let's Talk About Accrued Rebates

What is a Rebate Accrual?

With rebate deals, it is common to earn rebates at a different rate to which you receive them. The rebate accrual is the amount of rebate that has been earnt, but not yet received (or for customer rebates, the amount that is owed but not yet paid).

For example, you may earn a quarterly rebate based on overall spend with a given supplier, but that supplier might only pay that rebate at the end of the year. From an accounting perspective, this rebate income needs to be represented, or ‘accrued’ for, at the time the rebate is earnt, not the time it is received.

This is a problem for merchants and distributors where their profit margin relies heavily on rebates. If profit and loss statements are based only on cash in the bank, then profits will appear far less than reality until the receipt of the final rebate payment. The same can be said for suppliers, where profits would appear far higher until the previously unaccounted for rebate payments were made at the end of the trading period.

Accurately forecasting sales, purchases and their associated revenue is vital to the accurate calculation of accruals -- and, ultimately, profit and loss. Organizations must have complete confidence in their rebate accruals process, and develop a structured and rules-based approach to rebate accounting, forecasting rebate revenue, and creating a clear audit trail that fully justifies accrual decisions.

What is an Over Accrual?

When a company overestimates the amount of rebates it expects to pay out in a given period, it creates an over accrual. This means that the company sets aside too much money to cover these rebates, leading to an inflated liability on its books. Consequently, its expenses appear higher than they should be, reducing the reported profit for that period.

For instance:

Suppose a company overestimates its rebate obligations by $100,000 in January. In February, when the overestimated rebates are not paid out, the reported expenses will be lower by $100,000, artificially inflating the profit for February.

An over accrual of rebates can signal to auditors that the company's accounting department may need to refine its processes. Accurate forecasting of rebates is crucial for maintaining the integrity of financial statements and ensuring transparency for stakeholders.

To prevent over accruals, it's prudent to only make accrual entries when the amount to be recorded is readily calculable. If there's uncertainty or fluctuation in the amount, it's advisable to err on the side of caution and record the most conservative figure.

What is an Under Accrual?

An under accrual occurs when the estimated amount of a rebate accrual journal entry falls short. Consequently, an under accrual of a rebate boosts profit for the recording period, whereas an under accrual of rebate revenue reduces it.

Accruals are typically set up as reversing entries in accounting software. This means the opposite of the original entry is recorded at the start of the next accounting period, effectively neutralizing the impact over two periods. Thus, an under accrual in one period generates the reverse effect in the subsequent period.

For instance:

  • Suppose in April, the company under accrues $3,000 for anticipated rebate expenses.
  • Consequently, in May, the expenses will be understated by $3,000, leading to an overstatement of profits for that period.

Auditors closely scrutinize such situations to ensure that expenses are accurately recorded, as failure to do so can artificially inflate profits, potentially misleading stakeholders.

The Dangers of Poor Accounting for Rebate Accruals

Of course, there are very serious consequences if rebates are mishandled, and profits are over or under-stated. If companies don't account enough money to pay upcoming expenses, they're often faced with a last-minute challenge to reallocate funds and cover unexpected claims. Worse yet, in some extreme cases, under-accruing can force organizations to restate their earnings, seriously impacting corporate value.

Several companies have hit the headlines because they've improperly accounted for rebates and, as a result, overstated profits. Tesco is probably the most famous in the UK, where profits were overstated by over £250m and the Serious Fraud Office was brought in to investigate.

Monsanto, the suppliers of the popular weedkiller -- Roundup, were given an $80m penalty after it allegedly misstated its earnings, owing to problems with rebate accounting in France, Germany and Canada. It is reported that payments made to distributors were recorded as selling, general and administrative expenses, rather than rebates, which increased gross profits from Roundup in those countries.

IFRS has landed

How IFRS 15 has Changed Accounting for Accrued Rebates

In 2018 a new standard, IFRS 15 came into effect published by the International Accounting Standards Board. This forced businesses to adhere to strict and harmonised rules for revenue recognition, and fuller disclosure on their financial statements — especially those that have to account for rebates, discounts and incentives.

That ability to record and track all aspects of a rebate agreement, from the details of a deal to the claims processing and financial reporting, is now under more scrutiny than ever. Because of this, more and more companies are starting to look at specialist software like Enable to help ensure both financial compliance and support improved margins.

Challenges for Rebate Accounting Teams

IFRS states that “Where a contract contains elements of variable consideration, the entity will estimate the amount of variable consideration to which it will be entitled under the contract”.

This can be hugely problematic for rebate accountants. Not only do they have to understand and document the agreements that have been made (we recently prised apart a contract that had no less than 300 deals contained within it!), rebate accountants have to work with buyers to understand the probability that its inclusion will not result in a significant revenue reversal in the future when the uncertainty has been subsequently resolved.

It makes perfect business sense to create deals that are geared around influencing behaviour but based on actions, not promises.  The difficulty is that we have to account for those promises (contractual agreements) in some way.

Year-end Revenue Recognition Principles

Year-end revenue recognition refers to the accounting standards that govern when and how a company recognizes revenue in its financial statements at the end of a fiscal year. Revenue recognition is a critical aspect of financial reporting, as it directly impacts a company's performance and profitability.

Year-end revenue recognition can become complicated when dealing with factors such as supplier and customer rebates due to:

  • Contingent nature of rebates
  • Estimation of rebate amounts
  • Timing of recognition
  • Variable considerations
  • Impacts on transaction price
  • Contract modifications

Recording Year-end Revenue Recognition

So, here are a few questions to ask yourself when recording year-end revenue:

       
  •        Did you have clarity on how to show the value of rebates in your accounts?    
    •    
  •        Was it clear what you should accrue for through year-end revenue recognition
    •    
  •        How easy was it to find out which procurement deals had yielded what rebates and are you sure you claimed for everything that you are owed?    
    •    
  •        And how might you improve on that in the future?    

To regain control over accrued rebates, companies must take a hard look at their current rebate accounting processes and if necessary, implement a rebate management solution to address the gaps that some accounting systems leave behind. See how Enable can help you regain control.

Category:
Finance