#cfa-level-1 #reading-25-understanding-income-statement #revenue-recognition
Another revenue recognition issue that became particularly important with the emergence of e-commerce is the issue of gross versus net reporting. Merchandising companies typically sell products that they purchased from a supplier. In accounting for their sales, the company records the amount of the sale proceeds as sales revenue and their cost of the products as the cost of goods sold. As internet-based merchandising companies developed, many sold products that they had never held in inventory; they simply arranged for the supplier to ship the products directly to the end customer. In effect, many such companies were agents of the supplier company, and the net difference between their sales proceeds and their costs was equivalent to a sales commission. What amount should these companies record as their revenues—the gross amount of sales proceeds received from their customers, or the net difference between sales proceeds and their cost?
US GAAP indicate that the approach should be based on the specific situation and provides guidance for determining when revenue should be reported gross versus net.23 To report gross revenues, the following criteria are relevant: the company is the primary obligor under the contract, bears inventory risk and credit risk, can choose its supplier, and has reasonable latitude to establish price. If these criteria are not met, the company should report revenues net. Example 5 provides an illustration.