Hello-We are considering purchases a company who employs circuit board designers. The designers, now our employees, would create the design of the circuit boards then we would send the design to a 3rd party manufacturer to actually assemble the boards for sale. We would never stock the inventory but we will arrange for the 3rd party supplier/manufacturer to drop ship the merchandise on our behalf. We would like to structure the deal as FOB destination, with the thought that the the 3rd party supplier will retain liability for the products until they reach the customer. We are hoping that this shields us from having to record inventory and a liability on our books related to the shipped inventory. My question is will that work? My assumption is that if the agreement is structured as FOB shipping point, our company will retain liability and have to book inventory until the product reaches the customer which could be nightmarish to track. What would we value the inventory at if we had to do that?Also, would EITF 99-99 gross revenue versus net revenue apply in this case?If you could please provide references to actual accounting pronouncements, that would be greatly appreciated. Thank you.
Country/State/Province of question: VA
Accounting Research Manager
Dear Friend,First of all, as I understand from your question, your business, i.e. the core business of the Company that you intend to purchase is "Designing and Consulting" and actually manufacture the circuit board. Now, having said this, it is VERY IMPORTANT to know if your company is just designing the boards or would also be selling it. Getting it manufactured by a third party manufacturer can just be arrangement and getting delivered there directly can be a matter of logistic.Let us take the scenario that your company would be designing it and getting it manufactured from a third party and as a matter of logistics, you would get the inventory shipped directly from the supplier to the third party manufacturing facility. In this case, it is YOU who would be purchasing the Inventory and getting it directly delivered at the manufacturing site would be a "Matter of logistics" and you WILL HAVE to record the Inventory. The Inventory valuation would be the purchase price of the Inventory.Now, the liability issue. since you are NOT stocking the Inventory, you can certainly have the FOB agreement which can have the liability of the inventory while in shipment to the manufacturer on the supplier. This is often insured by the supplier. The question of YOUR liability does not arise as you are NOT in actual possession of the Inventory.Now the EITF 99-99 gross revenue versus net revenue issue --- Recording revenue at gross means that you record all of the revenue from a sale on your income statement. Recording revenue at net usually means that you’re only recording a commission on the sale as your entire 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.In my opinion, you should record revenue at gross. This means that you record all of the revenue from a sale on your income statement. This is because it the entire process -- i.e. sending the inventory directly to the manufacturer is JUST A PROCESS INFLUENCED BY LOGISTICS and nothing more than that.So, to sum up, yes, you WILL have to record Inventory, and that would be at cost. Secondly, YES.. You can have FOB arrangement and no liability needs to be taken by you, it can be taken by supplier.Thirdly, revenues should be recorded at gross. This is like any other business and this DOES NOT involve just a commission business. It is a typical designing and manufacturing business and as a part of logistics, involves third party manufacturing.You may "Accept:" this if it helps as this is the only way we get credit for the work. Alternatively, please feel free to revert with additional queries.Warm Regards,
Hello-I really appreciate the quick answer. Just a couple of clarifications:1. We will be designing AND selling the circuit boards. Please note that we are ONLY designing the circuit boards. We are outsourcing the a 3rd party manufacturer to actually assemble them. 2. The supplier and the manufacturer in our case would be the same company. The 3rd party manufacturer would need to find their own supplier. Once finished, the circuit boards will be shipped to our customers from the manufacturers site. Does this change your answer at all?
Dear Friend,1. YES.. I understand this that you are just designing. But note that the third party manufacturer is manufacturing FOR YOU. So, technically, it is YOU who is the manufacturer but you are just outsourcing the process. So my opinion stands unchanged.2. Ok.. Even then, the question of liability does not arise so far as YOU are concerned. You may have agreement with the third person manufacturer and / or supplier on the liability issue and vide that agreement you can keep it on them.No.. My answer would not change.You may "Accept:" this if it helps as this is the only way we get credit for the work. Alternatively, please feel free to revert with additional queries.Warm Regards,
For your answer to #1, do you have specific guidance on this? Just as a reference. Thats my last question. I'm thrilled with this answer and will accept once i know if there is guidance.
Dear Friend,There cannot be specific guidance on it. You have to read the GAAP, and also the basic business concepts that it is YOU who is manufacturing. Now, since you do not want to do it yourself, you will outsource it. Remember this is your INTERNAL ISSUE.Let me site you an example. Most drug companies get "third party manufacturing" done as their specialty is in marketing and distribution. Now, this is a internal issues for them that should they manufacture themselves or get it outsourced. The decision to outsourced is a "commercial decision" taken while taking logistics and cost benefits issues in mind. SIMILAR theory apply to you.You may "Accept:" this if it helps as this is the only way we get credit for the work. Alternatively, please feel free to revert with additional queries.Warm Regards,
Graduated in law with Emphasis on Finance and have have been working in financial sector for over 8