In July 2017, the Ministry of Finance issued the "Accounting Standards for Business Enterprises No. 14-Revenue" (hereinafter as 'the New Standard'). The New Standard is convergent with "International Financial Reporting Standards No. 15-Revenue from Contracts with Customers".
For companies that are both listed domestically and overseas and preparing financial statements according to IFRS or Accounting Standards for Business Enterprises, the effective date of the New Standard was 1 January 2018. For companies that are only listed domestically, the effective date was 1 January 2020. For the rest of the domestic companies, the effective date is 1 January 2021.
The old revenue accounting standards issued by the Ministry of Finance in 2006 took the timing of transferring risks and rewards associated with the products or service to customers as the timing of revenue recognition. However, for the New Standard, the timing of revenue recognition was the transfer of control rights, and a five-step method was introduced to provide guidance for specific transactions or events and contract costs.
To help companies apply the New Standard properly, the Ministry of Finance published guidelines for applying the New Standards in companies involving in general transportation services on 11 December 2018. In view that most foreign-invested companies in China are engaged in the international trade business, this article will develop the guideline of transportation services by discussing whether the ocean freight that occurred during the trade should be considered as a separate single obligation and recognised as revenue under Incoterms.
Interpretation of Incoterms
According to the "General Rules for the Interpretation of International Trade Terms", the terms were grouped in four basically different categories:
- Group E (the "E" term Ex Works): the seller only makes the goods available to the buyer at the seller's own premises
- Group F (the "F" terms FCA, FAS and FOB): the seller is called upon to deliver the goods to a carrier appointed by the buyer
- Group C (CFR, CIF, CPT and CIP): based on Group F, the seller has to contract for carriage, but without assuming the risk of loss of or damage to the goods or additional costs due to events occurring after shipment and dispatch
- Group D (DAF, DES, DEQ, DDU and DDP): the seller has to bear all costs and risks needed to bring the goods to the place of destination
Accounting treatment of revenue recognition under old revenue standards (Version 2006)
According to Old Revenue Standards, Revenue from the sale of goods should be recognised when, and only when, all the following conditions have been satisfied:
- The enterprise has transferred to the buyer the significant risks and rewards of ownership of the goods
- The enterprise retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold
- The amount of revenue can be measured reliably
- It is probable that the economic benefits associated with the transaction will flow to the enterprise
- The costs incurred or to be incurred in respect of the transaction can be measured reliably
Therefore, for manufacturing companies involved in international business trade under all forms of Incoterms, transportation service revenue should be recognised alongside the sales revenue generated from sales of goods when associated risks and benefits have been transferred to customers. The transportation service revenue would not be recognised separately.
Accounting treatment of revenue recognition under new revenue standards
According to the New Standard, when the company's revenue is recognised for related products or services is no longer the time when related risks and rewards are transferred, but the time when control of related products or services is transferred. The transfer of risks and rewards represents the transfer of economic benefits, and the transfer of control rights represents the transfer of economic benefits and represents the transfer of the right to use goods or services.
Generally, under normal circumstances, transportation activities that occur before the transfer of control to the customer do not constitute a single performance obligation but are only activities undertaken by the enterprise to perform the contract, and the related costs should be regarded as the contract performance cost. On the contrary, the transportation activities that occur after the transfer of control to the customer may indicate that the company has provided transportation service to the customer, and the company should consider whether the service constitutes a single performance obligation.
Therefore, according to Incoterms, companies' products have transferred the control rights related to the products to the customers when they leave the destination for group E, F, and C. Therefore, when the goods leave the destination, the enterprise should only confirm the revenue related to the goods. Simultaneously, companies need to treat transportation services as a separate performance obligation and recognise transportation service revenue when the goods are delivered to the destination. For Group D, the control rights related to the company's goods are transferred to the customer when they arrive at the destination, so transportation services should be regarded as the contract performance costs incurred when the company performs the contract rather than recognising transportation service revenue.
