Transaction Value Additions, Related Party Transactions, and Accounting

John Metrich, Deleon Trade

Advanced Topics in Customs Compliance Conference

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Additions to Value and General Ledger Reviews

ACCOUNTING PRINCIPLES

ADDITIONS TO VALUE OVERVIEW AND EXAMPLES

TARGETED GENERAL LEDGER

TESTING AND CASE STUDIES

QUANTIFYING AND DECLARING

ADDITIONS TO VALUE

RELATED PARTY TRANSACTION

RISKS AND CASE STUDY

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Accounting Terminology

Double Entry Accounting - Every financial transaction has equal and opposite effects on two or more accounts.

Account – A unique place in the general ledger that is used for recording a balance and history of changes to that balance.

General Ledger – Master record of all accounts and transactions.

General Ledger Trial Balance – Contains the summary of balance of all accounts at a specific point in time (e.g., trial balance as of 12/31/20).

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Basic Accounting Equation

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• Assets– Cash– Accounts

Receivable– Equipment

Assets Liabilities Equity

• Liabilities– Accounts

Payable– Notes Payable– Accrued

Expenses

• Equity– Stockholder

Equity– Retained

Earnings– Dividends

Expanded Accounting Equation

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Assets Liabilities Equity= +

Assets Liabilities= +

Assets Liabilities= +

Capital Retained Earnings+

Capital Revenue Expenses Dividends+ - -

Income Statement or P&L

Balance Sheet

Debits and Credits and the Accounting Equation

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Assets Liabilities= + Capital Revenue Expenses Dividends+ - -

Double Entry Accounting and the General Ledger• Example – Company receives an invoice for a design engineering expense of $18,000

for the design of a new product to be imported from a supplier (Category IV Assist –more on this later).

• Company pays invoice 30 days later

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Debit CreditEngineering Expense (Exp. - I/S) $18,000

Accounts Payable (Liab. -B/S) $18,000

Debit CreditAccounts Payable (Liab. - B/S) $18,000

Cash (Asset - B/S) $18,000

General Ledger Trial Balance – Debits and Credits

Account Debit Balance Credit Balance

Cash (Asset – BS) $1,500,000

Accounts Receivable (Asset – B/S) $2,000,000

Equipment (Asset – B/S) $1,000,000

Accounts Payable (Liability – B/S) $500,000

Equity (Equity – B/S) $3,000,000

Sales (Revenue – Inc. Stmt.) $5,000,000

Cost of Goods Sold (Exp. – Inc. Stmt.) $3,000,000

Operating Expenses (Exp. – Inc. Stmt.) $1,000,000

Total $8,500,000 $8,500,000

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XYZ Corporation – Trial Balance Ending 12/31/19

General Ledger Trial Balance – Positive and Negative

Account Account Balance

Cash (Asset – BS) $1,500,000

Accounts Receivable (Asset – B/S) $2,000,000

Equipment (Asset – B/S) $1,000,000

Accounts Payable (Liability – B/S) ($500,000)

Equity (Equity – B/S) ($3,000,000)

Sales (Revenue – Inc. Stmt.) ($5,000,000)

Cost of Goods Sold (Exp. – Inc. Stmt.) $3,000,000

Operating Expenses (Exp. – Inc. Stmt.) $1,000,000

Balance $0.00

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XYZ Corporation – Trial Balance Ending 12/31/19

Transaction Value – 19 CFR 152.103

• Price actually paid or payable (PAPP) for the merchandise when sold for exportation to the United States, plus certain statutory additions to the price.

• General presumption that all payments from the buyer to the seller are dutiable – Generra Sportswear - CIT

• Supplemental Payments = High Risk

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PAPP - Supplemental Vendor Payments

• Tooling Charges or Setup Fees• Non-Recurring Engineering (NRE) or

design fees• Milestone payments• Material acquisition charges

– Spot buy charges– Metal surcharges

• Rework• Testing• Transfer Pricing True-Ups on related

party transactions• Currency Risk Sharing Agreements

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Statutory Additions to Value

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Transaction Value = Price Actually Paid or Payable (PAPP) + Certain Additions:

• Commissions (Selling)• Royalties• Assists• Packing• Proceeds

Transaction Value = PAPP + CRAPP

Commissions

• Selling commissions where an agent is working on behalf of the supplier are an addition to value.

• Buying commissions where the agent it working on behalf of the importer are generally exempt.

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Royalties

• Royalties paid to the seller are generally added to the value

• Royalty payments paid to an unrelated 3rd party are reviewed on a case-by-case basis, utilizing a 3-part test:– Was the merchandise manufactured under patent?

– Was the royalty involved in the production or sale of the imported merchandise?

– Can the company import the product without paying the royalty?

• Yes, yes, no = generally dutiable, with a primary focus on question 3

• License fees for trademark usage not typically added to value

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Royalty Example

• A Japanese pharmaceutical company developed a drug for treatment of metastatic cancer. The U.S. affiliate purchases and imports purchases the drug from the Japanese affiliate. In addition to the purchase price, the U.S. company also agrees to remit 10% of the gross sales of the product in the U.S.• The 10% gross sales royalty would be considered an addition to the value.

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Assists – 19 CFR 152.102(a)(1)• Assist - means any of the following if supplied directly or indirectly,

and free of charge or at reduced cost, by the buyer of imported merchandise for use in connection with the production or the sale for export to the United States of the merchandise:

i. Materials, components, parts and similar items incorporated in the imported merchandise.

ii. Tools, dies, molds and similar items used in the production of the imported merchandise.

iii. Merchandise consumed in production of the imported merchandise.

iv. Engineering, development, artwork, design work, and plans and sketches that are undertaken elsewhere than in the United States and are necessary for production of the imported merchandise.

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Category (i) Material Assist Examples

• A U.S. company ships steel pipe to a fabrication company in Canada. In Canada, the fabrication company manufactures and welds on tool joints on the ends of the pipe for use in oil drilling. The U.S. company imports the finished drill pipe. – The steel pipes shipped to Canada are category (i) material assists.

• A U.S. company ships glass, aluminum extrusions, and rubber gaskets to an assembler in Thailand. In Thailand, the supplier assembles the materials into curtain wall for use in the exterior of commercial buildings. The U.S. company imports the finished curtain wall.– The glass, aluminum, and rubber are category (i) material assists.

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Category (ii) Tooling Assists Examples

• A U.S. company sources molds from a supplier in China and ships the molds to an injection molding company in Vietnam. The molds are utilized to produce cell phone cases, which are then imported by the U.S. company.– The molds shipped to Vietnam are category (ii) mold assists.

• A U.S. company purchases machining tooling and ships it to a company in Canada. The U.S. company also ships forged drill heads for machining at the plant in Canada. The U.S. company imports the machined drill heads.– The machining tooling is a category (ii) assist.– The forged drill heads are category (i) material assist.

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Category (iii) Consumables

• A U.S. company ships cutting tools and cutting oil to a manufacturer in Mexico to cut glass to shape in the manufacture of windows. The U.S. company imports completed windows from the manufacturer.– The cutting tools are a category (ii) assist.– The cutting oil is a category (iii) assist.

• A U.S. company provides sublimation paper to a clothing manufacturer in Guatemala. The sublimation paper is heated to imprint logos and designs on to clothing. The U.S. company imports the printed clothing.– The sublimation paper is a category (iii) assist.

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Category (iv) Engineering and Design Examples

• A U.S. company outsources its component design drawings to its related party technology center in India. The product design drawings are provided to suppliers in Asia in order to produce the required components, which are then purchased and imported by the U.S. company.– The design drawings are a category (iv) assist.

• A U.S. company produces design drawings for components at its U.S. Engineering Center. The product drawings are provided to suppliers in China so that they can produce the components. The U.S. company imports the completed components produced with the product designs.– The product designs are not an assist because they were produced in the United States.

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Value of an Assist

• Cost of acquiring/producing the assist plus the cost of transporting the assist to the place of production

• Apportionment will be made in a reasonable manner appropriate to the circumstances and in accordance with generally accepted accounting principles. 19 C.F.R. § 152.103(e).Total value may be apportioned over:1. The first shipment,2. The number of units produced up to the time of the first shipment, or3. The entire anticipated production.4. Other methods of apportionment in accordance with Generally Accepted Accounting

Principles.

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Packing Costs and Proceeds

• Any costs incurred by the importer for all containers, coverings, labor, and materials used in packing the imported merchandise must be declared as part of the value.

Packing Costs

• Proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue, directly or indirectly, to the foreign seller must be added to the value of the imported merchandise.

Proceeds

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General Ledger Value Targeting

Transaction Targeting

Controller or Accounting Manager

Account Targeting

Trial Balance

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Account Targeting

• Primary focus on income statement expense accounts with a secondary focus on balance sheet liabilities

• Target “Accounts of Interest” based on keywords:

Tooling/OffsiteTooling

Molds/Dies

Setup Charges Packaging Expense

Rework Expense Commission Expense

EngineeringExpense

Transfer Price Adjustment

Research and Development

Royalty Expense/Payable

Management Fees Material Premiums

Purchase Price Variance

DepreciationExpense

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Account Detail• Date• Account Number(s)• Supplier/Vendor• Description• Identifiers• PO• Invoice• Accounting Doc• Part Number

Work with Accounting to gain familiarity with account transactions

Coordinate with Purchasing, Engineering, and other departments as applicable

Rule out accounts with low or insignificant risk; avoid pitfalls

For accounts with identified risk, obtain transaction detail

Get the details in the activity download

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Transaction Targeting – Where to Focus

Transactions that impact imported

merchandise

• Don’t get hung up on transactions that only affect domestic purchases

Identified risks from conversations with

departments

• Suppliers/Vendors• Transaction types• Document types

Transactions that fit a value risk profile

• Tooling expenses paid to foreign suppliers

• Outsourced engineering paid to a foreign firm

• Royalty expenses paid related to imported products

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Targeting Example – Engineering (Original Example)• Example – Company receives an invoice for a design engineering expense of $18,000

for the design of a new product to be imported from a supplier

• Company pays invoice 30 days later

• Where would you target?

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Debit CreditEngineering Expense (Exp. - I/S) $18,000

Accounts Payable (Liab. -B/S) $18,000

Debit CreditAccounts Payable (Liab. - B/S) $18,000

Cash (Asset - B/S) $18,000

Targeting Example 1 -Engineering• Engineering• Non-Recurring

Engineering (NRE)• Setup Fees• Research and

Development• Design• Outside Services• Cost of Goods Sold*

(Only if necessary)

Utilize Engineering and Purchasing to narrow search

Target expense accounts

Avoid pitfall accounts where possible

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Targeting Example 2 – Tooling (Capitalized)

• Capitalized Assets vs. Expensed Assets– Asset Capitalization Threshold (e.g., >$2,500)

• Capitalized Asset = Depreciated Asset• Example - $10,000 tool purchased from supplier with 5-year useful life

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Debit CreditEquipment (Asset – B/S) $10,000

Accounts Payable (Liab. -B/S) $10,000Accounts Payable (Liab. -B/S) $10,000

Cash (Asset – B/S) $10,000

Targeting Example 2 – Tooling (Capitalized)

• Depreciation – Accounting method of allocating the cost of a tangible asset over its useful life

• Example Annual Transaction: $10,000/5 years = $2,000/year

• Transaction will repeat each year until tooling is fully depreciated or asset is sold or disposed

• Unique to Assets - Fixed Asset Ledger with location codes

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Debit CreditDepreciation Expense (Expense – I/S) $2,000

Accumulated Depreciation (Liab. -B/S) $2,000

Targeting Example 2 – Tooling (Expensed)

• Typically Assets <$2,500• Expensed Tooling Journal Entry

• Target Expense accounts and utilize feedback from purchasing• Keyword Targets: Tooling, Equipment, Supplies, Dies, Molds, Setup Fee, Non-Recurring

Engineering, etc.

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Debit CreditTooling Expense (Exp. - I/S) $1,500

Accounts Payable (Liab. -B/S) $1,500Accounts Payable (Liab. -B/S) $1,500

Cash (Asset – B/S) $1,500

CBP Targeting Example – General Ledger Request

• Focused Assessment Questionnaire Excerpt

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Step 1

CBP Targeting Example - Account Detail Request

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Step 2

CBP Targeting Example - Transaction Detail Request

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Step 3

Transaction Review and Quantification

Documentation

Obtain and review supporting documentation for transaction as applicable (invoice, PO, contract, etc.) and ascertain the impact on imports and valuation

Coordination

Coordinate with Purchasing, Accounting, etc. to determine scope of issues identified• Suppliers• Part numbers• Total Value

Quantification

Quantify and declare via an appropriate methodology (e.g., reconciliation)• First import• Allocation

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Royalty Quantification Example

• After an analysis of the general ledger, you identify an account titled “Royalty Expense”.

• During a discussion with Purchasing and Accounting, you identify that a royalty is paid to ABC Corp, which is a foreign supplier.

• The royalty contract is provided by Legal detailing the following:– A royalty is paid to the supplier on the imported “Turbo” units.– The royalty payment is based on the gross sales of the “Turbo” units.– Royalty payments are due on the 15th of the subsequent month

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Royalty Quantification Example – Account Detail

Account Number-Name Date Amount Description

500357-Royalty Exp. 10/31/19 $29,000 Oct. Accrual – Turbo

500357-Royalty Exp. 11/1/19 ($29,000) Oct. Reversal – Turbo

500357-Royalty Exp. 11/8/19 $2,000 Oct. Royalty - Beta

500357-Royalty Exp. 11/15/19 $29,000 Oct. Royalty – Turbo

500357-Royalty Exp. 11/30/19 $30,000 Nov. Accrual – Turbo

500357-Royalty Exp. 12/1/19 ($30,000) Nov. Reversal – Turbo

500357-Royalty Exp. 12/8/19 $2,000 Nov. Royalty - Beta

500357-Royalty Exp. 12/15/19 $30,000 Nov. Royalty – Turbo

500357-Royalty Exp. 12/31/19 $32,000 Dec. Accrual – Turbo

12/31/19 $95,000 Pre-Closing Trial Balance

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• How do we quantify? What stands out?

Royalty Quantification Example – Account Detail

Account Number-Name Date Amount Description

500357-Royalty Exp. 10/31/19 $29,000 Oct. Accrual – Turbo

500357-Royalty Exp. 11/1/19 ($29,000) Oct. Reversal – Turbo

500357-Royalty Exp. 11/8/19 $2,000 Oct. Royalty - Beta

500357-Royalty Exp. 11/15/19 $29,000 Oct. Royalty – Turbo

500357-Royalty Exp. 11/30/19 $30,000 Nov. Accrual – Turbo

500357-Royalty Exp. 12/1/19 ($30,000) Nov. Reversal – Turbo

500357-Royalty Exp. 12/8/19 $2,000 Nov. Royalty - Beta

500357-Royalty Exp. 12/15/19 $30,000 Nov. Royalty – Turbo

500357-Royalty Exp. 12/31/19 $32,000 Dec. Accrual – Turbo

12/31/19 $95,000 Pre-Closing Trial Balance

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• Accrual? Reversal? Beta? December royalty?

Royalty Quantification Example – Accruals/Reversals• Accruals – Matches revenue and expenses to the current accounting period

• Reversing Accruals – Transactions undertaken to reverse out the prior month’s accruals.

• Payment – $29,000 has no net effect on November expenses

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10/31/19 Debit CreditRoyalty Expense (Exp. - I/S) $29,000

Accrued Expenses (Liab. -B/S) $29,000

11/1/19 Debit CreditAccrued Expenses (Liab. - B/S) $29,000

Royalty Expense (Exp. - I/S) $29,000

11/15/19 Debit CreditRoyalty Expense (Exp. - I/S) $29,000

Cash (Asset - B/S) $29,000

Royalty Quantification Example – Accrual Net Effect

• Net Accounting Effect– Royalties - $29,000 – October– Cash - $29,000 – November– Accrued Expenses - $0

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10/31/19 Debit CreditRoyalty Expense (Exp. - I/S) $29,000

Accrued Expenses (Liab. -B/S) $29,000 11/1/19 Debit CreditAccrued Expenses (Liab. - B/S) $29,000

Royalty Expense (Exp. - I/S) $29,000 11/15/19 Debit CreditRoyalty Expense (Exp. - I/S) $29,000

Cash (Asset - B/S) $29,000

Royalty Quantification Example – Other Issues

• Beta Royalty – Discussions with Purchasing and Legal confirm this royalty is related to domestic purchases and should not be included in quantification.

• December Royalty – Should pull account detail for January 2020 to confirm December royalty payment.

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Account Number-Name Date Amount Description

500357-Royalty Exp. 1/1/20 ($32,000) Dec. Reversal – Turbo

500357-Royalty Exp. 1/15/20 $32,000 Dec. Royalty – Turbo

500357-Royalty Exp. 1/31/20 $39,000 Jan. Accrual – Turbo

1/31/20 $39,000 Month End Trial Balance

Royalty Quantification Example - Quantification

Account Number-Name Date Amount Description

500357-Royalty Exp. 11/15/19 $29,000 Oct. Royalty – Turbo

500357-Royalty Exp. 12/15/19 $30,000 Nov. Royalty – Turbo

500357-Royalty Exp. 1/15/20 $32,000 Dec. Royalty – Turbo

$91,000 Total

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• Calculate Total Royalty Expenses for 2019

• Identify relevant ACE import activity• Total import value of “Turbo” entry lines - $1,500,000

• Calculate apportionment ratio• $91,000/$1,500,000 = 6.0667%

• Each relevant import entry line should be increased by 6.0667%

Royalty Quantification Example – Value Quantification

Entry Date Entered Value Value Increase Revised Value

7/3/19 $135,000 $8,190 $143,190

7/27/19 $46,000 $2,791 $48,791

8/1/19 $168,000 $10,192 $178,192

9/2/19 $223,000 $13,529 $236,529

9/17/19 $217,000 $13,165 $230,165

10/4/19 $329,000 $19,959 $348,959

11/18/19 $318,000 $19,292 $337,292

12/6/19 $64,000 $3,883 $67,883

Totals $1,500,000 $91,001 $1,591,001

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Related Party Transactions - Risks

• The burden of proof is on the importer to show that the relationship does not affect the price. – Test Values– Circumstances of Sale– IRS rules and CBP rules are not the

same• Transfer Pricing Agreements and Studies

– Transfer Pricing Matrix– Transfer Pricing Adjustments

• Other valuation adjustments– Engineering

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Circumstances of the Sale

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1. The price was settled in a manner consistent with the normal pricing practices of the industry in question;

2. The price was settled in a manner consistent with the way the seller settles prices for sales to buyers who are not related to it; or

3. The price is adequate to ensure recovery of all costs plus a profit that is equivalent to the firm’s (meaning parent company’s) overall profit realized over a representative period of time in sales of merchandise of the same class or kind.

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Transfer Pricing Example

• After an analysis of the general ledger, you identify an account titled “Transfer Price Correction”.

• During a discussion with Accounting and Tax, you identify that the U.S. company makes transfer price adjustments to its related affiliate in Sweden.

• The transfer pricing agreement is provided by Tax detailing the following:– Transfer price adjustments are made with the related affiliate on a periodic basis.– The transfer pricing agreement outlines that the U.S. importer needs to recognize

an operating profit within 8-14%, as outlined in the transfer pricing study.

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Transfer Pricing Example – Account Detail

Account Number-Name Date Amount Description

500452-Transfer Price Cor. 5/1/20 $350,000 2020 Debit Memo

500452-Transfer Price Cor. 11/1/20 $550,000 2020 Debit Memo

500452-Transfer Price Cor. 12/1/20 ($100,00) 11/1 Credit Adjustment

12/31/20 $800,000 Pre-Closing Trial Balance

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• How do we quantify? What stands out?

Transfer Pricing Example – Account Detail

Account Number-Name Date Amount Description

500452-Transfer Price Cor. 5/1/20 $350,000 2020 Debit Memo

500452-Transfer Price Cor. 11/1/20 $550,000 2020 Debit Memo

500452-Transfer Price Cor. 12/1/20 ($100,00) 11/1 Credit Adjustment

12/31/20 $800,000 Pre-Closing Trial Balance

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• Debit Memo• Credit Adjustment• Positive vs. Negative

Transfer Pricing Example

• Confirm details with tax and/or accounting• Debit memos vs. credit memos – who is getting paid?• Do transactions apply to current year or prior year?• Will there be any adjustments in 2021 for 2020 transactions?• What is the reason for the adjustment?• Does the transfer price adjustment apply to all imports or a subset of imports from

the related affiliate?

• Other Considerations• Is transaction value the appropriate basis of appraisement?• Does the related party pricing meet the requirements of a circumstances of sale

test or test values?

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Transfer Pricing – Details Confirmed and Quantification

• Transactions relate to all 2020 imports from affiliate• Adjustment was related to a calculation error in the 11/1/20 debit memo• Transaction is properly appraised under transaction value as it meets test 3

of the circumstances of sale test.• There will be no additional adjustments. Total Dutiable amount is $800,000• Total Dutiable amount would be apportioned to 2020 imports by value.• Identify relevant ACE import activity

• Total import value of Swedish Affiliate entry lines - $16,000,000

• Calculate apportionment ratio• $800,000/$16,000,000 = 5%

• Each relevant import entry line should be increased by 5%

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General Ledger Auditing Summary

VALUE CRITERIA INTERDEPARTMENTAL COMMUNICATION

EXPENSES AND LIABILITIES

AVOID PITFALLS –DON’T OVERDO IT

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QUESTION & ANSWER TIME

&Q A

John MetrichSr. Trade Auditor

Former CBP Auditor & Assistant Field Directorjohn@deleontrade.com

DELEON TRADE LLCCustoms Compliance Consultants

Houston – Chicago – Minneapolis – Denver