Accounting for Trade Spend (#367)

What is Trade Spend?

Trade spend is the amount paid by a manufacturer to enhance consumer recognition of its products, as well as to make its products more visible within the retail space, with the overall goal of increasing customer purchases. For example, this might mean paying a retailer to stock its goods in a prime location on its shelves, which is known as paying a slotting fee.

Or, the manufacturer might offer a promotional discount on certain products, or maybe offer a rebate if you buy its product within a certain period of time. And, it might enter into a cooperative advertising campaign with some of its retailers, where the retailers pay for advertising and then deduct some or all of this expense from the next invoice they’re paying to the manufacturer.

Accounting for Trade Spend

So what is the accounting for trade spend? The general rule is that trade spend is assumed to be a reduction of the manufacturer’s reported revenue. For example, slotting fees, volume rebates, and discounts are all usually netted against gross revenue, which means that your net revenue figure could be quite a bit smaller than your reported gross revenue figure.

But there are some exceptions. Trade spend can instead be recorded as an expense if the manufacturer can show that it received an identifiable benefit from having made the expenditure. In order to prove that there’s been an identifiable benefit, you usually have to show that the expenditure could have involved a separate transaction with some other party than the retailer that bought the goods.

For example, you could make a case that cooperative advertising expenditures should be listed as a marketing expense, rather than a deduction from gross revenue, since you could have paid some other party than the retailer for the advertisements. Why does this matter? Because most companies want to keep their reported net revenue figure as high as possible, even though the end result is the same net profit figure at the bottom of the income statement.

Another example. You’re a food manufacturer, and you pay Trader Joe’s $10,000 to conduct demonstrations of your guacamole product in its stores. By incurring that expense, you’re increasing the sales of your product, which is an identifiable benefit. In this case, you could probably record the expenditure as a selling expense.

Here's another example. You have a cooperative advertising agreement with Home Depot, which is paying for advertising that features your aluminum ladders. And you pay Home Depot $5,000 to run these ads. If Home Depot were not running these ads, you could run them yourself to increase your ladder sales. In this case, you can record the expenditure as a marketing expense.

Now let’s try an unusual example. You’re a brand-new manufacturer of baby diapers, and you pay Costco a slotting fee of $50,000 to place your diapers in a really good position on its shelves. Since this is a slotting fee, it gets netted against your gross revenues. The problem is, because you’re a new manufacturer, your gross sales are only $40,000, so you end up with net negative sales of $10,000. You should charge this net negative sale amount to expense.

There’s also a fair value issue with recording trade spend. When you’ve paid out a certain amount of money on trade spend and you have a justifiable case for recording it as an expense, the amount recorded as expense cannot exceed the fair value of the benefit received. If the amount is more than fair value, then the excess amount paid should still be recorded as a reduction of gross revenue. For example, if you pay $8,000 to a retailer for a marketing benefit and only get $2,000 of fair value from it, then the remaining $6,000 is recorded as a reduction of gross revenue.

Now, let’s talk about when to accrue an expense for trade spend. That would be as soon as you think it’s probable that you’ll incur the expense. For example, if you’ve offered a retailer a ten percent sales rebate if it sells at least 20,000 units of your product, then you should accrue the sales rebate expense as soon as you think the retailer is actually going to sell 20,000 units.

How to Track Trade Spend

Another item is how to track trade spend. This can be difficult, because your sales and marketing people are probably the ones setting up these deals, and they might very well not be keeping very good track of what deals were offered to which customers. The end result is all kinds of discounts being taken by retailers when they pay their bills – none of which you were expecting.

Now, you can just live with this, but it makes for atrocious financial reporting. It’s essentially impossible to make any realistic estimates of what your net sales or net profits are going to be. A better approach is to force the sales and marketing department to only enter into deals that have already been approved and included in the annual budget. This means talking to the sales and marketing people all the time about which trade spend items have been recognized on the books, and which ones are still hanging out there. By doing that, you can impress upon them that it’s really important to only spend the amount on trade spend that they were allocated in the budget.

And a final item, which is measuring whether you earned a profit on trade spend. To do this, you should calculate the increase in sales during the promotional period, which is presumably caused by the trade spend. Then calculate the standard gross margin on this incremental increase in sales, and then subtract out the cost of the trade spend. The result is the profit or loss on trade spend.