USA Contract Manufacturing Accounting Questions

[PhotonMaverick]

We are about to implement a new arrangement with a contract manufacturer. To start, we will provide the necessary materials from our stock (a one off bulk shipment to the manufacturer). Eventually, the manufacturer will provide the procurement services. I am struggling to account for this relationship from a US GAAP perspective. Any help is appreciated.

1.) Should we transfer the ownership of our inventory to the contract manufacturer at the time of the bulk inventory transfer, when the CM begins to manufacture the product, or should we maintain ownership of the inventory throughout the process?

2.) As a follow-on to part 1, Would the contract manufacturers revenue Include the value of our customer supplied materials or would they have to exclude this in their reporting?

3.) To monitor our inventory at the contract manufacturer, how frequently should we receive consumption reports?

 

[kirby]

1. No transfer of ownership. You did not sell the materials to the CM. The materials remain yours. But move their cost to an account like "Materials at CM" so you know what you have and where.

If the materials cost at the CM is significant:
Find out details of insurance for those offsite materials. Somebody better have them insured, you or CM and if it is CM you need proof. If it is your company, then tell your insurance agent you have offsite inventory and make sure it is covered by your policy.

And somebody from your company better go visit periodically to do a physical inventory and then compare to what you think is there per your records.

2. An issue for the CM's accountant, not you.

3. Depends on dollar value of the inventory at CM. If not material, ask for info at least monthly so you can close books. If material, then see how often you can get it. Particularly important if the CM is outside of the US. One more thing, someone in your company should have inventory control meaning if your company did the manufacturing then historically you should get x finished product out of y materials. So someone in your company needs to see if same ratio is being upheld at CM else your materials may "disappear".

 

[Dave In Capital]

I have to agree with Kirby. But I'm a little bit confused by what is meant by "the contract manufacturer's revenue including the value of our customer supplied materials." If you're not referring to the contractor's books, then I'd have to infer that you're describing a recording of payments to the contractor in relation to work that was done using supplies provided by your own customers.

In regards to everything else, I thought I might run these JEs past you to see if they mesh with your interpretation:

To record acquisition of raw materials (RM): Dr. RM, Cr. AP / Cash

To record transfer of RM to contractor: Dr. Work in Process, Cr. Raw Materials

To record receipt of finished goods from contractor: Dr. Inventory, Cr. Work in Process

To record fees paid to contractor: Dr. Inventory, Cr. AP / Cash

 

[PhotonMaverick]

Thanks both! Dave, I think your JE follow a logical progression. The company was/is trying to handle the transaction differently. See the JE below:

Option 1
dr raw materials inventory / cr ap with initial raw material supplier
dr AP w contract manufacturer / cr raw material inventory
dr Finished Goods inventory / cr AP w contract manufacturer

the net AP balance with the Contract manufacturer would account for the material credit.

Option 2

dr raw materials inventory / cr ap with initial raw material supplier
dr AR w contract manufacturer / dr revenue and dr COGS / cr raw materials
dr finished goods inventory / cr AP w contract manufacturer

In this option, the company recognizes revenue on the transfer of material to the contract manufacturer then buys back finished goods for future sale to the end customer. By the way, this option I don’t support but am struggling to justify my position with proper accounting (ASC) documentation.

 

[kirby]

If your mgmt believes they have made a sale in option 2, then they should charge sales tax to the contract manufacturer. This is when cold reality kicks in. Like I said in item 1 in my earlier post, there is no sale to the CM.

 

[Dave In Capital]

Again Kirby is correct about the transaction with CM not constituting a sale in conventional terms. Also, I want to point out that revenue does not carry a debit balance. So, the second JE in Option 2 would be lopsided.