In teaching my Principles of Financial Accounting class last week, I stumbled across an observation I hadn’t noticed before.  I explained to my students that as a business strategy to expand sales, companies offer a range of incentives to their customers: discounts for paying early, rights to return merchandise, warranties, and credit. 

However, I then noticed that under U.S. GAAP as I understand it, and as it appears in the textbooks I’ve got on my shelves, there appears to be an inconsistency in how these incentives are handled:

  • Sales discounts — recorded as a contra-revenue account (that is netted against gross sales)
  • Sales returns — recorded as a contra-revenue account (also netted against sales)
  • Warranties — recorded as an expense (NOT netted against sales)
  • Credit losses — recorded as an expense (NOT netted against sales).

I hadn’t thought about this before.  Is there a conceptual reason underlying this?  As I laid the argument out, these are similar in that they all stem from the desire to augment sales by providing incentives, and so that seems to argue for parallel accounting treatment.

This observation became relevant as well as I discussed the new Revenue Recognition Exposure Draft in my Contemporary Accounting Issues class, as the proposal seems to indicate that warranties and credit losses will be netted against sales (see paragraphs IG16 and example 4,  and IG79 and example 20 of the ED).

Personally, I see an advantage to the gross presentation of sales, with separate presentation of the costs of providing customer incentives, because that provides explicit information to financial statement users that enables inferences about the underlying business strategy choices.  So although the ED does appear to correct the inconsistency, it does so in a manner that might be viewed as information-reducing to users.

I welcome any thoughts on this issue.