Accounting for preproduction costs related to long-term supply arrangements

July 6, 2013

Numerous suppliers (e.g., in the automotive industry) work with their customers to design and develop products or molds, dies, and other tools to manufacture such products. These costs may be called preproduction costs related to long-term supply arrangements. Under these arrangements, customers sometimes reimburse suppliers for the incurred costs. In this article, we will discuss accounting for such costs.

1. Nature of preproduction costs related to long-term supply arrangements

US GAAP distinguishes two kinds of preproduction costs related to long-term supply arrangements:

  • Costs of design and development of products
  • Costs of design and development of molds, dies, and other tools

Molds, dies, and other tools can be owned by the customer or by the supplier. So, the second category noted above can have the following subcategories:

  • Costs of design and development of molds, dies, and other tools owned by the supplier
  • Costs of design and development of molds, dies, and other tools not owned by the supplier

Accounting for the preproduction costs related to long-term supply arrangements is the following:

  1. Costs of design and development of products are expensed as incurred unless they are reimbursable by the customer.
  2. Costs of design and development of molds, dies, and other tools that the supplier will own are capitalized to the extent of the unreimbursable amount and become part of the supplier’s fixed assets.
    1. An exception to this rule is design and development costs which are not reimbursable by the customer and which relate to new technology. Unreimbuserable costs related to new technology are expensed as incurred.
  3. Costs of design and development of molds, dies, and other tools that the supplier will not own can be accounted for in one of the two ways:
    1. If the supplier has a non-cancelable right to use the molds, dies, and other tools, then the unreimbursable costs should be capitalized as an asset on the balance sheet and amortized over the shorter of the expected useful life of the tooling or the minimum production period.
    2. If the supplier does not have a non-cancelable right to use the molds, dies, and other tools, the unreimbursable costs should be expensed as incurred.
  4. If a contractual guarantee for reimbursement exists for design and development costs that otherwise would be expensed, those costs shall be recognized as an asset as incurred. In this case, contractual guarantee means a legally enforceable agreement in which the amount of reimbursement can be objectively measured and verified. Thus, reimbursable costs for product or tooling design and development should be recorded on the balance sheet (e.g., as accounts receivable or other assets) until reimbursement is received. At the time of reimbursement, such costs are offset with the funds received.

The last point is important because suppliers may receive reimbursement for costs which would have been expensed otherwise. Such costs can be recorded as an asset until the reimbursement is received. For example, if a supply agreement indicates the supplier will be reimbursed for the costs of design and development of products, such costs can be capitalized.

Finally, any capitalized costs should be assessed for impairment.

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