Ecommerce Accounting Best Practices

12.09.21 02:02 PM

Ecommerce Accounting Best Practices

Running an online business is easy if you follow the eCommerce best practices. Else it will become more challenging day by day for you to run and manage your eCommerce business.

To become a successful online business you must know and follow the best practices.

E-Commerce is all about scale and big volume. Managing limited orders is easy but for managing volume, you need a business process in place. So that when you start getting more orders you can manage them without any difficulty.

eCommerce accounting best practices

What Are Ecommerce Accounting Best Practices?

One of the most important parts of ecommerce best practices is revenue recognition. Ecommerce entrepreneurs must know when to recognize the revenue in their books. 

The point of revenue recognition is different in normal accounting and eCommerce accounting. And this is where most eCommerce businesses fail.

What Is Revenue Recognition? 

Revenue recognition is the timing at which one should book profit or loss in their books. 

In normal accounting practices, revenue gets recognized at the time of the transaction.

But in ecommerce, there are many uncertainties like return, replacement, order cancellation, etc.
These uncertainties affect accounting and create a burden on most ecommerce businesses.

When An Ecommerce Company Should Recognize The Revenue In Their Accounting Books?

As an e-commerce company, you are either selling goods or services. Below we read for both sale of goods and services, and how revenue should get recognized for both. 

So let's understand when we should be recognizing the revenue of the online companies.

When eCommerce accounting should recognize revenue

Rule Of Ecommerce Accounting.

Revenue should get recognized when the significant risk and rewards of ownership get transferred to the buyer, and no uncertainty remains about the payment.

Got Confused? Let's understand this in more detail.

Ecommerce Accounting For The Sale Of Goods

  • For e-commerce companies using 3rd party logistics like Delivery, FedEx, Bluedart, India Post, etc. 
    • For Pre-paid orders where the customer pays money in advance. Here revenue must get recognized after goods get handed over to the courier company.
    • For Cash On Delivery (COD) Orders. Here recognize the revenue after cash gets received by the logistic provider. Note: Why you are not waiting here till you receive the money? As you are now certain about the payment from the logistic provider.
    • In case of Return Period Guarantee to the customer. Many companies assure their customers of easy returns, like Amazon and Flipkart. In such cases, revenue must get recognized after the return period gets over. We recognize the revenue here as the risk gets transferred to the buyer after the return period.
  • When an e-commerce company using its own courier service for delivery.  
    • For Pre-paid orders. Revenue should get recognized when the product gets delivered to the buyer. 
    • For Cash On Delivery (COD) orders. Recognize the revenue after you receive the cash in your hand. 
    • For Return Period Guarantee. Revenue gets booked after the return period is over.

Accounting For The Rendering Of Services

Ecommerce services are of different types like subscription-based, consultancy, tuition fees, event-based, etcetera. 

And for different durations that can be the short-term or long-term duration. 

Short-term services can be limited duration or use like up to a month like a few minutes, hours, days or days, use, etcetera. 

And Long term service duration is longer than a month like a quarterly, yearly, lifetime, etc.

Let's understand how to record revenue for services of different types and durations.

  • For Short Term Services. Like where the user books the cab and the cab driver picks and drops the passenger to its destination. Here revenue gets recognized after the journey of the passenger gets completed. 
  • For Long Term Services like Subscriptions. Here you book your revenue for the proportion of service that you have provided to the customer. For example, a 1-year subscription bought by the customer. Here we periodically book the revenue after each month's completion. 
    (Total 1-year subscription sold, after 1st-month completion revenue gets booked for 1st month and for pending 11 months liability gets created, after 2nd-month completion revenue gets booked for 2nd month, similarly for all pending period.)
  • Life Time, for example, a lifetime membership. In such cases, service duration should not less than 5 years in accounting books. But you can take more than 5 years also based on your industry experience and estimates.
  • In case of refundable period. Some sites offer refund assurance to their customers for a limited period. In such a scenario one should book revenue after the refund period is over, before that it's a liability.

Accounting Practice For Loyalty Program

eCommerce Loyalty Program

Best practices for loyalty programs like cashback, loyalty points, credit coupons, etc. 

  • For Immediate Cashback. Cashback and discounts at the time of sale should get recorded under sale discounts. 
  • For Claim Later Loyalty Points. Loyalty points that can be claimed at a later stage need building a separate provision in books. Here record all issued points as liability till it gets utilized by the customer after that book them under discounts.

Special Use Cases For Revenue Recognition

Now let's take some more or special use cases and understand when to record revenue in such scenarios. 

  • Goods get delivered but with the condition of the installation. If you are selling some products that required installation service. Here revenue should get recognized only after providing the installation service.
    (Please note that in some cases the installation process is very simple in nature. In such cases, you can record the revenue at the time of delivery. Example: factory fitted television that only required unpacking, power connection, and antennae.)
  • Pre-order or special orders. Here payment is made in advance by the customer in either partial or full for goods not held in stock. In such a case revenue is recognized only after the delivery, before that the advance received by the company is a liability.
  • Revenue from hotel room booking, flight booking, banquets, events, artistic performance, etcetera. In such cases, revenue should get recognized after the event takes place.

E-Commerce Book Keeping Best Practice

A single product with separately identifiable components

Let's understand this with some examples.

  • Example 1. A shaving kit is a bundled product with separately identifiable components that you can also sell, like (shaving cream + shaving brush + gel + razor + pouch)
  • Example 2: Set of 3 t-shirts (1 Red + 1 Blue + 1 White)
  • Example 3: Cable Service (Installation + Set Top Box + Internet + Home Phone)

In such cases, an e-commerce company should set up the individual items first in books on fair value. This practice will help if any uncertainty or any special events happen. For example: for combo offer sale, partially damaged delivery, for partial returns, etcetera. 

Following these ecommerce best practices will help the entrepreneur to focus more on the scaling of its business and less on managing it. And also helps them with a clear and more accurate accounting.