Incoterms Rules and Revenue Recognition

Despite it not being written for this purpose, why do companies use Incoterms Rules for Revenue Recognition?   Some businesses think by that by selling under ExWorks as it is seen as the best Incoterms Rule for early revenue recognition.  And yet in practice these busineses often as in more organise and pay the international freight and even send a separate invoice to the customer to pay these additional costs – without amending the contract term.  This mis-use of the Incoterms Rules often comes from the belief that companies cannot recognise the revenue into their accounts until they received a Proof of Delivery.  But Incoterms Rules have not been written for revenue recognition even though it may establish a “known delivery point”.

Incoterms Rules aren't law and their use is not mandatory.  They are standard terms internationally agreed through the ICC which can be included in contracts but they only cover only a minor part of what is legally required in a contract. If a company wishes to write its own terms and conditions covering the points Incoterms address – legal point of deliver, transfer of risk (not title) and division of costs then fine.  Incoterms do not address title (ownership), insurance for the shipments, payment, force majeure, dispute settlement, breach of contract, to name just a few so whether you use an Incoterms Rule in you contract or not you must include additional terms to cover these key requirements.  Of course with terms written specifically for a contract we then come to the potential issues 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 on 1936 and, if used, they provide a global standard for the interpretation of the delivery and risk elements of a contract.

Once included in contracts the term of the relevant Incoterms Rule is legally binding. 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.

Let’s return to revenue recognition.  This 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, now it is more complicated and comes under audit provisions, like the USA Sarbannes Oxley rules.  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/ or, collected by the first carrier from the seller’s premises and the supporting evidence for this will be ….”

Remember, Incoterms are not written for revenue recognition and 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 terms and conditions, but it settles a ton of potential issues.

Article written by Sandra Strong - Strong & Herd LLP Managing Partner

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