Consumer Packaged Goods (CPG) companies have unique accounting considerations due to the nature of their business. CPG companies typically have high volumes of transactions, which can make accounting challenging. These companies also face a high degree of competition and must manage their costs carefully to maintain profitability. In this article, we will discuss some of the key accounting considerations for CPG companies.
Generally, revenue is recognized when goods are sold, but CPG companies often offer discounts, promotions, and other incentives to encourage sales, which can make revenue recognition more complex.
The Financial Accounting Standards Board (FASB) has issued Accounting Standards Codification (ASC) 606, which provides guidance on revenue recognition for all companies, including CPG companies. The core principle of ASC 606 is that revenue should be recognized when a company satisfies a performance obligation by transferring a promised good or service to a customer.
For CPG companies, revenue recognition will be dictated by the shipping terms (i.e., FOB shipping destination or FOB shipping point).
Additionally, CPG companies need to account for discounts. Discounts should be recorded as a reduction in sales revenue. The amount of the discount should be clearly documented and recorded in the company’s financials in a designated account within the revenue section of the P&L.
Inventory management is another important accounting consideration for CPG companies. These companies typically have a large amount of inventory on hand, which can be costly to maintain. CPG companies must manage their inventory carefully to avoid overstocking or understocking. Overstocking can lead to increased storage costs, while understocking can lead to lost sales and reduced profitability.
CPG companies can use either the last-in, first-out (LIFO) or first-in, first-out (FIFO) method to value their inventory. LIFO assumes that the most recent inventory purchased is sold first, while FIFO assumes that the oldest inventory is sold first. CPG companies must select the method that best reflects their business operations and properly disclose this in their financial statements.
Inventory reserves are an important consideration for CPG companies. Inventory reserves are used to account for potential losses on inventory and are recorded as a contra asset account on the balance sheet.
CPG companies must assess the likelihood of inventory becoming obsolete and create inventory reserves to account for potential losses. This may occur due to changing consumer preferences or market trends or when a product is approaching its expiration date. CPG companies may also create inventory reserves to account for potential losses due to damage or deterioration of inventory.
When establishing an inventory reserve for the first time, you will debit the inventory reserve related account within the Cost of Goods Sold (COGS) section of the P&L and credit your inventory reserve account on the Balance Sheet. This reserve is an estimate and should be recorded based on historical trends, industry trends, or other substantiated data.
Cost of Goods Sold
CPG companies must record the COGS for each product they sell. This includes the cost of the materials used to produce the product, as well as any direct labor or overhead costs. In addition, CPG companies must account for any indirect costs, such as packaging and shipping, that are included in the cost of goods sold. COGS are recorded as an expense on the P&L.
COGS needs to be recorded on the P&L in the month corresponding to the related sale (matching principle).
CPG sales can lead to merchandise returns, customer credits for various reasons, have right-of-return stipulations, and even offer warranty terms to its customers. As such, sales returns and allowance accounts should be established and maintained to properly reflect expected sales, COGS, inventory, and accounts receivable within the period on both the P&L and Balance Sheet.
Returns and allowances can be estimated based on historical data, industry trends, and estimates of future returns/claims.
To properly account for returns, a business needs to maintain accurate records of all returns, including the reason for the return, the date, and the value of the returned product. This information is important for tracking patterns of returns and identifying potential issues with products or the sales process.
CPG companies must also consider tax implications when conducting business. CPG companies may be subject to sales tax, income tax, and other taxes depending on their location and the nature of their business. CPG companies must comply with tax regulations and accurately account for any taxes owed.
As you now know, the accounting considerations for CPG companies require careful management. Revenue recognition, inventory management and reserves, COGS, returns, and tax considerations are all important factors that CPG companies must consider. By carefully managing these factors, CPG companies can maintain profitability and succeed in a highly competitive market.