Do you ever offer customers a product or service, but don’t actually incur the expense until much later? If so, you may have hidden lurking unrecorded liabilities just waiting to nip at your bottom-line in some future accounting period. Let’s take a look at common industry examples and how to deal with them effectively.
Extended Service Warranties
In the heating fuel and propane industries, it’s become commonplace to offer multi-year, upfront free or paid maintenance as a sales incentive when installing new equipment. The problem? The expenses come at times when there is no revenue! Even if an upfront fee is charged, the cash is received and booked at the time of install, but the expense of the actual service usually spills over into subsequent years. The solution?
With advance-paid maintenance contracts, amortize the revenue over the warranty period. Because tax code can be fickle, be sure to check with your CPA about the best way to match up your revenue with the timing of the expense. One method we’ve seen that appears to work well is to employ the use of a warranty reserve. To keep the IRS happy, though, you will need to substantiate your reserve with documented warranty fulfillment experience, similar to a bad debt reserve.
If maintenance is thrown in for nothing, again consider setting up a reserve account for calculated anticipated expenses based upon your company’s expense experience. With any reserve account, the goal is to match revenue and expense timing, not tax avoidance. OK, it’s nice when they coincide, but don’t let tax minimization override your good judgment. And always involve your CPA in the mechanics to stay within IRS rules.
If you loan any equipment to customers, there is a cost to moving that equipment on and off a site. Most marketers are so thrilled to have a new account that they don’t charge an install fee. When you wish you had a fee is when the customer calls you to take it out because they are going to your competition! The solution? Equipment installation and removal fees in your lease contract. Clever marketers always use install and removal fees in lease contracts.
You can set your install fee at a very nominal rate and removal fee at a high rate when the desire is to keep a customer long-term. If a lease is for an obviously temporary job, such as a road construction project, install and removal fees should be identical. (Remember Equipment Tracker’s automated lease contracts feature!)
These are just two common examples of hidden liabilities from promises to customers. Make a list of what lurking expenses you may have, then develop workable accounting solutions. If you are acquiring other companies, be sure to ask about customer promises in your due diligence process. You may discover liabilities you didn’t know you were buying!