To: Management of Spider-Web Corporation
Re: Accounting Treatment for a Barter Transaction
Facts of the Case
Spider-Web Corporation (Spider) owns various websites that it uses to advertise customers services. The company also assists other companies that have websites to manage their advertisement space. Besides using its websites, the company also places adverts on the websites of various companies since they have entered into an advertisement contract. In such instances, the Spider pays these companies a commission for using their advertisement space.
When offering advertisement, Spider charges customers the advertisement fees based on clicks made on their advertisements. Besides placing these advertisements on its website, Spider also places them for a fee on the websites of various partners that they have entered into various agreements. Generally, advertisers only have agreements with Spider. Spider, on the other hand, uses advertisement space of various customers when it does not have enough space for these adverts.
- Should Spider record the revenue it earns from placing ads for various third-party advertisers on Web sites owned by the partners on a gross or net basis? Provide an analysis supporting your conclusion.
Spider will only record the revenues earned by placing advertisements on third-party advertisements on the fair value (gross) basis if the value is determinable according to FASB regulations, otherwise, it will record them on a net basis.
Barter Transaction Regulation
The kind of transaction that Spider engages with its customers and partner websites is called a barter transaction. In general, a barter transaction is a kind of transaction where the seller (who acts as an agent in the case of Spider) does not receive financial gain from the transaction, rather he/she transfers these financial gain and obligation to another seller (partner website providers). It may also entail the transfer of nonmonetary assets where no asset is received, instead, a service may be offered by the trader. In the case of Spider, once the company decides to place advertisements on the websites of partner companies, it also transfers a significant amount of financial benefits to these individuals. Consequently, the financial gains that it makes from these of agreements are small. The main contentious issue, therefore, arises whether Spider should record the amount that it receives through these agreements since the cash that it actually receives is usually smaller than the agreement price. In practice, the bulk of this cash is transferred to third party partners.
The decision on whether to record the gross or net amount depends on the nature of the transaction as well as the ability to access all information pertaining to the transaction according to the guidelines provided by FASB. To begin with, FASB requires that all advertising companies, such as website providers disclose all revenues and expenses in the advertisement of barter transactions at the realizable fair value. However, since it is at times it is difficult to accurately determine the appropriate fair value, FASB requires that where the fair value cannot be accurately determined, that on each income statement the volume and type of income surrendered or received to be indicated in the income statement. Accordingly, where it is difficult to determine the fair value, the net value is used instead.
ASC 605-20-50-1 (FASB 2016; PWC 2014)
Entities shall disclose the amount of revenue and expense recognized from advertising barter transactions for each income statement period presented. In addition, if an entity engages in advertising barter transactions for which the fair value is not determinable within the limits of paragraphs 605-20-25-15 through 25-18, information regarding the volume and type of advertising surrendered and received (such as the number of equivalent pages, the number of minutes, or the overall percentage of advertising volume) shall be disclosed for each income statement period presented.
Basically, the fair value of a barter transaction advertisement can be determined if there is sufficient historical information of a similar transaction. In this case, the historical transaction must be of parties that are not related to the current advertiser. In addition, there must have been “real” payments. Offsetting of barter transaction costs, such as where both parties agree to cancel debts owned by the other party cannot be used to determine the fair value. Consequently, where the fair value cannot be determined from unrelated third parties, or if there are such transactions (third party and similar transactions) but have been paid through of setting, then the net amount should be used. FASB calls this amount to be the carrying amount. Simply, carrying amount is the amount that the advertiser pays less the payment made to offset these costs to the partner businesses.
Revenue and expense shall be recognized at fair value from an advertising barter transaction only if the fair value of the advertising surrendered in the transaction is determinable based on the entity’s own historical practice of receiving cash, marketable securities, or other consideration that is readily convertible to a known amount of cash for similar advertising from buyers unrelated to the counterparty in the barter transaction. An exchange between the parties to a barter transaction of offsetting monetary consideration, such as a swap of checks for equal amounts, does not evidence the fair value of the transaction. If the fair value of the advertising surrendered in the barter transaction is not determinable within the limits of paragraphs 605-20-25-16 through 25-18, the barter transaction shall be recorded based on the carrying amount of the advertising surrendered, which likely will be zero.
When determining whether to use the fair amount, an important factor that must be considered is time. In regards to time, the comparable transactions must have occurred within a period of 6 months and the time of the current transaction. In addition, there should not have been any significant changes in the economy during this period. Significant changes include issues such as a change in interest rates or a fall in advertisement costs. If there are significant economic changes, transactions that have occurred within the last six months cannot provide a representative figure of the fair value of the transaction. Besides these considerations, cash transactions that occur after the barter transaction cannot be used to determine the fair value of the transaction. As aforementioned, if the fair value cannot be determined, the business must use the net value.
A period not to exceed six months prior to the date of the barter transaction shall be used to determine whether a historical practice exists of receiving cash or marketable securities for similar advertising. If economic circumstances have changed such that prior (but not more than six months old) transactions are not representative of current fair value for the advertising surrendered, then a shorter, more representational period shall be used. In addition, it is inappropriate to consider cash transactions subsequent to the barter transaction to determine fair value. That is, there is no look-back allowed to value and record past barter transactions.
The similarity of the transaction is another factor that should be considered when determining whether to consider a transaction to represent a fair value. Simply, similarity refers to the similar appearance in character and nature of the transaction. In this case, an advert must be made on the same channel/ media or same website. In addition, there must be similarities in terms of the circulation, prominence, timing, demographics, as well as duration. Circulation, in this case, refers to the market where the advertisement is made. Prominence refers to the location and size of the advert in the website, timing is the duration that the advert will be marketed. Finally, demographics is the age and gender of the targeted audience.
For advertising surrendered for cash to be considered similar to the advertising being surrendered in the barter transaction, the advertising surrendered must have been in the same media and within the same advertising vehicle (for example, same publication, same website, or same broadcast channel) as the advertising in the barter transaction. In addition, the characteristics of the advertising surrendered for cash must be reasonably similar to that being surrendered in the barter transaction with respect to all of the following:
- Circulation, exposure, or saturation within an intended market
- Timing (time of day, day of week, daily, weekly, 24 hours a day/7 days a week, and season of the year)
- Prominence (page on web site, section of periodical, location on page, and size of advertisement)
- Demographics of readers, viewers, or customers
- Duration (length of time advertising will be displayed).
In addition to the aforementioned, the determination of the determination of the fair value is also limited to the quantity or volume of the qualifying past advertisement. In this case, the amount paid in a past qualifying advertisement can only determine the fair value of a barter transaction that is of equal or lesser value. Since there cannot be a partial determination of a fair value of a barter advertisements, transactions that do not have similar and equal or more past advertisements must be recorded in their net values.
The quantity or volume of advertising surrendered in a qualifying past cash (or near-cash) transaction can evidence only the fair value of an equivalent quantity or volume of advertising surrendered in subsequent barter transactions. In other words, a past cash transaction can support the recognition of revenue on advertising barter transactions only up to the dollar amount of the cash transaction. When the cash transaction has been used to support an equivalent quantity and dollar amount of barter revenue, within the limits of paragraphs 605-20-25-15 through 25-18, that transaction cannot serve as evidence of fair value for any other barter transaction.
In the determination of whether to use fair value of non-monetary assets or the use of barter credits the fair value of the nonmonetary asset shall be presumed to offer a clear and more reasonable value for this transaction. Accordingly, in such a transaction the net value shall not be used. In these instances, the nonmonetary asset will be presumed to offer a better estimate for the exchanged asset. However, if the barter credits can be readily converted by the company, they will be used to indicate the value of the transactions. In this case, the conversion must be from a private an independent quoted market price.
In reporting the exchange of a nonmonetary asset for barter credits, it shall be presumed that the fair value of the nonmonetary asset exchanged is more clearly evident than the fair value of the barter credits received and that the barter credits shall be reported at the fair value of the nonmonetary asset exchanged.
However, that presumption might be overcome if an entity can convert the barter credits into cash in the near term, as evidenced by a historical practice of converting barter credits into cash shortly after receipt, or if independent quoted market prices exist for items to be received upon exchange of the barter credits. It also shall be presumed that the fair value of the nonmonetary asset does not exceed its carrying amount unless there is persuasive evidence supporting a higher value.
Inasmuch as Spider prefers to use cash for its barter transaction, there are instances where an advertiser might decide to pay the adverts on a non-cash basis. Therefore, although Spider would pay its partner websites cash for hosting these advertisements, it would receive no cash from the customers. In these instances, the company must estimate the fair value of the non-cash item that it is receiving. Accordingly, it will record these costs on their fair value form and not in net value. Notably, for such a transaction to occur, the company must first establish that there is a valid contract as stated in ASC 606-10-25-1 and that the estimated cash benefits are collectible.
To determine the transaction price for contracts in which a customer promises consideration in a form other than cash, an entity shall measure the estimated fair value of the noncash consideration at contract inception (that is, the date at which the criteria in paragraph 606-10-25-1 are met).
The terms of establishment of a valid contract according to FASB, which must be adhered to when entering into a noncash contract.
An entity shall account for a contract with a customer that is within the scope of this Topic only when all of the following criteria are met:
- The parties to the contract have approved the contract (in writing, orally, or in accordance with other customary business practices) and are committed to perform their respective obligations.
- The entity can identify each party’s rights regarding the goods or services to be transferred.
- The entity can identify the payment terms for the goods or services to be transferred.
- The contract has commercial substance (that is, the risk, timing, or amount of the entity’s future cash flows is expected to change as a result of the contract).
- It is probable that the entity will collect substantially all of the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer.
Company With Similar Analysis
Google Inc. is a company that was established in 1995 that offers similar services as Spider-Web Corporation. The company offers search and advertising services on its websites as well as those of partner companies. The company aims at providing users of its websites with advertisements that are relevant to them, which will trigger them to click on the advert and direct them to the advertisers. These type of adverts are called performance advertisements. They are made using the company’s program AdWords, which enables them to be auctioned to partner companies that receive a share of these advertisements revenues. Google also uses brand advertising through videos, text, images, and interactive advertisements. Various advertisers use these type advertisements in marketing and brand building campaigns (SEC, 2016).
Alternative Accounting Treatment (IFRS 15)
As an alternative to using FASB guidelines on barter transactions, companies in countries that use International Financial Reporting Standards may use IFRS 15. However, unlike US GAAP, IFRS 15 does not specify when to use gross amount or net amount. Generally, this guideline states that a contract, such as a barter transaction, has commercial substance. Therefore, parties to the contract must put into considerations factors such as timing, the amount of entity’s future cash flows, risk, and probable changes in the contract. In light of this, it is at the discretion of the accountant to make judgments based on the prevailing circumstances to select the most appropriate criterion (Ernst and Young, 2015: Deloitte, 2016). In light of this, it would be the duty of Spider-Web Incorporation to choose the most appropriate accounting method based on the underlying conditions in its operations.
To sum up, Spider can only use the fair value if the advertisers decide to use non-cash payments and these amounts can be accurately estimated. In addition, the advertisers must have entered into a valid contract with Spider. If an advertiser uses non-monetary assets or cash credits, which cannot be easily convertible in the market, the nonmonetary assets will provide the fair value of these transactions. If the barter credits are readily convertible and their value can be confirmed in the market, they will determine the fair value of the transaction. If there is sufficient historical information of a similar transaction that is of equal or higher volume from an independent third party, the transaction occurred less than six months ago, and there have been no significant economic changes, fair value is used. Otherwise, the net value is used. Finally, where the fair value of a transaction is not determinable, Spider will have to record the net income.
Presentation and Disclosure
- Determinable Price (Gross Basis)
Dr. Advertiser (Accounts Receivable) $24
Cr. Sales A/C $24
For the unpaid advertising service
Dr. Sales A/C $23
Cr. Advertising Expense A/C $23
For fees paid to third party agents
- Price cannot be determined (Net Basis)
Dr. Customer $1
Cr. Revenue $1
Net income earned from the transaction
In the above examples, Spider will only record the revenues earned by placing advertisements on third-party advertisements on the fair value (gross) basis if the value is determinable according to FASB regulations. In this case, the gross amounts $24 of revenue are recorded in the sales account. Later, underlying advertising expenses are subtracted in the income statement. These requirements are granted under (ASC 605-20-25-(15-18)). These regulations also require if this amount cannot be determined, the net basis to be used as an alternative. Noteworthy, IFRS 15 allows an accountant to choose either method for the accounting of the business depending on his/her judgements on its suitability in the company.
Deloitte. IFRS 15:Revenue from contracts with customers. (2016). Web.
Ernst and Young. Applying IFRS: The new standard affects more than just revenue. (2015). Web.
FASB. Accounting Standards Codification. 2016. Web.
PWC. Financial Statements Presentations. 2014. Web.
United States Securities and Exchange Commission (SEC). Form 10-K. Alphabet Inc. and Google Inc. Form 10-K. for the fiscal year ended December 31st 2015. (2016). Web.