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Use of Incoterms Rules for revenue recognition

Article Date: 01 December 2014

Despite it not being written for this purpose, why do companies use Incoterms Rules for revenue recognition?

I have just started a new role as an international trade compliance manager at a large, well-established business. One of the first things I started to look at was our use of Incoterms Rules. We were using ExWorks as a default term for all exports (EU and third country) unless the customer insisted on something else. It was nonsense in my opinion, especially as in more than 70% of cases our company organised and paid the international freight and sent a separate invoice to the customer to pay these additional costs — without amending the contract term.

I began a process of moving from ExWorks to FCA Terms and, in some cases, Group C or D terms. I have just been told to stop this and revert to ExWorks as it is seen as the best Incoterms Rule for early revenue recognition. Even waiting for the carrier to collect (FCA Terms) was deemed too long — and as for D Terms, well, I’ve been told that we cannot recognise the revenue in our accounts until we had received a Proof of Delivery. I have tried to explain that Incoterms Rules have not been written for revenue recognition but they are throwing terms like “known delivery point” and Sarbannes Oxley rules (SOX as they call it here) at me. Now I doubt myself, and we’re still shipping ExWorks.

This topic is very interesting and I have had similar experiences and faced similar difficulties with this kind of question in many businesses I visit. Incoterms Rules are not law and their use is not mandatory. They are standard terms internationally agreed through the ICC that can be included in contracts. The contracts then are legally binding. If a company wishes to write its own terms and conditions covering the points Incoterms address as well as others they do not, eg title, insurance, payment, force majeure, dispute settlement, breach of contract, etc (Incoterms cover only a minor part of what is legally required in a contract), then fine.

Of course, with terms written specifically for a contract, the potential issues arise of governing law and interpretation of the terms in a court of law if things go wrong. It was to address these issues that Incoterms Rules were originally created in 1936 and, if used, they provide a global standard for the interpretation of the delivery and risk elements of a contract.

What is a concern is when companies include in a legal contract a clause saying the contract is covered by an Incoterms Rules 2010 (eg ExWork/FOB) and then do not do what the term obligates them to do. For example, if the contract states the sale is covered by ExWorks (Incoterms 2010 Rules) then it is, in effect, a breach of contract to load the goods on the collecting vehicle, contract with the freight company for the international movement, etc. Revenue recognition is an important part of business.

In the old days (pre-Enron and Co’s inventive ways) you could only recognise revenue when the money hit your back account, but now it is more complicated and comes under audit provisions, like the Sarbannes Oxley ones you mentioned. Therefore, revenue recognition needs to be an independently agreed financial position along with the retention of title clause in the contracts, not tagged on to the Incoterms Rule used. For example “Revenue will be recognised when the goods are available for collection/collected by the first carrier from the seller’s premises, and the supporting evidence for this will be…”.

Remember, Incoterms are not just “not written for” revenue recognition (through the title transfer event), the ICC guide specifically says that’s not what they do. Keep Incoterms neat and tidy — they cover the supply chain delivery, transfer of risk and very little else.

A business needs finance, trade compliance, logistics, risk management, customer service, and sales to all work together to settle on this sort of thing, then train their teams to understand it. We’d recommend considering adding the insurance, title transfer, and Incoterms clauses to your invoices, domestic and international alike, writing them to cover all situations (yes, even L/C transactions where title transfer can occur at the bank window). It may add an inch and a half to the bottom of your invoices, but it settles a ton of potential issues.

Source:- Croners Wolters Kluwer Business

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