How ABC Helps Make Sense of Promotional Income Allowances

Promotional income (a.k.a. trade funding, rebates, discounts, allowances) is something of a double-edged sword. On the one hand, it's a major source of income and profit throughout a company's supply chain. According to AMR Research, trade funding can amount to 6%-15% of a typical retailer's revenue. Competition for these promotional dollars has intensified, along with pressures to increase profits from this important income source. One CFO interviewed summed it up by saying, "Customers are where we make our money, but vendors are how we make our profits."

On the other hand, promotional income is a difficult accounting practice to validate. Now, particularly in light of Section 302 of the Sarbanes-Oxley Act (SOA) which requires CEOs and CFOs to personally certify their financial statements, it's become even more of a nightmare. There are multiple definitions for promotional income, and just as many accounting practices for recording it. It can be recognized as revenue, or as a reduced cost of goods, or as a credit against marketing expenses.

Major Discrepancies

Such vague definitions have caused real trouble for some companies. For example, the 2003 audit of US Foodservice (a $17B public company) revealed major discrepancies related to promotional income, forcing US Foodservice to announce they had overstated profits in 2000 and 2001 by a minimum of $800 million. And that number is expected to increase before the SEC is done. In addition, seven major vendors to US Foodservice have been contacted by the SEC for further clarification on the dispersal of promotional income. All publicly traded companies involved in this scandal have seen their stock prices suffer. Analysts expect that this investigation will have a widespread impact on the U.S. food industry and the way food companies conduct business. Other industries that utilize promotional income as an incentive are closely watching the outcome this investigation. In an attempt to clear up the confusion associated with promotional income, the Financial Accounting Standards Board (FASB) released EITF 02-16 in November 2002. It states that payments for documented promotional activity will now be booked as reductions in the promotional expense account, while other undocumented payments will be recorded as reductions in cost of goods account.

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