Revenue Recognition - how to account for manufacturing molds?

If I understand this, your client "X" creates a mold requested by their client "B". That mold is then sold to their client "B". Client "X" safe keeps the mold so they can produce the product that the mold represents. If Client "B" decides to sever their relationship with Client "X", the mold would be returned.

So on production of the mold, its DL + DM and 3rd party costs is then booked to inventory. When you bill Client "B" for the mold, a credit revenue and inventory, a debit to CGS.

Whenever fabrication using Client "B"s mold (that they now own, since title was transferred when you invoiced) there is no longer an accounting trx for the mold; its out of the picture.

Your Client "B" may have additional accounting transactions (possibly to depreciate the mold), but your client ("X") is not involved.

Hope I understood correctly.

2

You are correct, revenue should be recognized on delivery. Delivery is one of the four basic rev rec criteria. Billing does not determine revenue recognition.

2

If the engineering services are under contract without regard to fabrication of the mold, then the engineering services can be recognized as soon as the design has received client acceptance. If the engineering contract is bound to the acceptance of the fabricated mold later in the process, you cannot recognize any revenue until delivery as Doug mentioned.

Similar to Architects where the design or plans are a separate product via acceptance from the construction, even though the Architect might be contracted to also manage the construction. Each element would have a separate contract with separate conditions, fees, and acceptance features.

This might be an exercise in how the contract is carefully worded to allow your client to recognize revenue upon acceptance of the services. This area is quite complex and there should be significant time spent crafting the various service agreements, and by policy not having side agreements between sales people and the client, which keep your client from being able to recognize revenue.

Large manufacturers have this issue many times, where they are required to design and build and test and find acceptance and the product could be several hundred thousand dollars in cost and they would like to recoup by billing and obviously recognize their revenue in the period they incur the costs to avoid losses. Side agreements can keep revenue from being recognized because they introduce a contingency the earned revenue to be delayed. I've seen this in medical equipment manufacturers and it is a real issue, this is why all sales agreements are typically reviewed by finance prior to signing and sales people are immediately under penalty of being fired if they have side agreements.

This could be an area of additional consulting revenue for you, in helping them to construct their engineering services agreements to ensure they can segregate that element from the fabrication.

Good luck.

1

Karen:
You need to look at the guidance on Multiple Element Arrangements at ASC 605-25. Your client is basically saying that the design services should be a separate unit of accounting from the fabrication of the mold. That is, the design services must have value to the customer on a standalone basis. That analysis is going to be based on the specific facts. If there are multiple vendors that could do the fabrication, and other companies that could provide design services, there may be a good case for separating the elements.
Even if it's a separate element, you still need to meet all of the revenue recognition criteria. In particular, your client will have to demonstrate that there is some form of customer acceptance of the design - for example a formal sign-off on the design before fabrication starts - in order to recognize the applicable portion of the revenue.

1

In answer to Wayne's follow up question - my client is a $6M manufacturer and does not have many formal order processes as a small business. That being said, my client provided a Quotation on the Mold with the following wording: "Molds are purchased by and are the property of [Customer]. Molds require a 50% upfront payment with balance due upon inspection of the first unit of product" the customer did place a Purchase Order reading "50% due with PO, remaining due upon completion of tool"; the tool being the mold. There is no distinction in the Quote or PO for design services or mold fabrication.

Margins on molds sold in the past were in the 5%-10% range but this mold has a 62% margin and the sale is much larger in dollars than any prior mold sale. My client doesn't want to wait until the mold is complete to recognize revenue because he says that there were engineering services performed in-house that went into the sale of the mold and he should be able to recognize that value. Meanwhile their VP Engineering says that his participation was really on the consultative selling side, including doing some work to prepare the Quote, and that there was little engineering services involved. [The VP Engineering does oversee the work of the fabricators and the contract design process when needed on any mold but his oversight seems to me to be more 'regular' overhead type work and not something that gets charged to COGS. I would charge the outside service costs to COGS though]

To me this is a classic case of the company needing to book more revenue and my client looking for any which way to increase sales.

Again, that being said, I do legitimately want to help them book as much revenue as possible given the true circumstances. If rewording the Quotes/POs to call out the different (actual) services provided can provide the appropriate support to recognize elements of the sale than I will certainly look into the guidance on this for support.

1