Tesla Accounting Policies: Revenue, Inventory, and Leases

Summary

There are certain aspects of Tesla's business model that distinguish it from other automakers. These manifest either in its accounting policies or in the ways in which those policies affect Tesla — but perhaps not its competitors, even if they utilize the same policies. The direct-to-consumer sales model in particular influences some policies, while the company's relative youth constrains how it handles things like warranty risk on its financial statements.

Tesla recognizes revenue on the basis of amounts it expects to collect, on vehicles delivered. This differs somewhat from companies that work with the dealer model, because Tesla sells directly to consumers and takes substantial deposits. Deliveries are equivalent to sales for the company — which is different from most automakers — and the pre-payment structure and waiting lists typically mean that the company will not face many returns. It does offer some buyback protection, which also helps it price any return that might occur.

The inventory valuation policy reflects the lower-of-cost-or-market principle, meaning Tesla must estimate the market value of its vehicles. If it expects to sell a vehicle at a loss, a writedown will be reflected in the year of the expected sale. This policy means the company may also face additional stress on its revenues if it finds itself selling a car for less than it costs to make.

Tesla's accounting of leases is noteworthy. For the Model S, the company maintains a buyback guarantee. On vehicles it sells via third-party financing, it treats this buyback guarantee as a lease for purposes of revenue recognition, and further amortizes the cost of the vehicle over the transaction period. This creates a situation where, instead of recording the car sold at full value as a sale, the revenue is recorded gradually over 39 months — despite the fact that no formal lease agreement exists, and that this treatment creates a distortion in reported revenue and costs. As a result, one must look at unit sales and the cash flow statement to supplement analysis of the income statement, owing to this quirk in lease recognition.

Accounting Policy #1 – Revenue Recognition

Tesla recognizes revenue under the following conditions: where evidence of an arrangement exists; where delivery has occurred and there are no uncertainties with respect to customer acceptance; where the pricing or fees are fixed or determinable; and where collection is reasonably assured. One point that differs from many automobile companies is the requirement that delivery has occurred to the end consumer. This is because Tesla delivers directly to the customer rather than to a dealership, and therefore the risk of returns is much lower. Tesla is responsible for both the sale of the car and the handling of financing. The company has often collected a significant portion of the purchase price from the customer prior to shipping the vehicle, which supports this approach to revenue recognition.

In 2016, the company began reporting leasing revenue separately from general automotive revenues. This is common practice in the automotive industry, but Tesla's leasing revenue was perhaps too small until that point to warrant separate reporting. Separating the two also distinguishes cash sales from lease sales and the attendant credit risk that Tesla bears as a result. It further allows an analyst reviewing the statements to parse the cost of goods sold for both the financing arm and the automotive arm of the company.

With respect to collection being reasonably assured, companies take several different approaches. Some prefer to recognize all revenue but record an expense for bad debts. Tesla instead chooses to recognize revenue only where collection is assured, and will not recognize revenue it expects will not be collected.

Accounting Policy #2 – Inventory Valuation

Tesla recognizes inventories at the lower of cost or market. Cost is computed using standard costs for vehicles and energy storage products, which approximates actual costs on a first-in, first-out (FIFO) basis. Costs for solar systems are recognized at actual cost.

There are two elements to this policy. The first is that Tesla uses FIFO as its costing system, which typically results in lower cost of goods sold but higher inventory valuation. If a company has a quick throughput of inventory, the choice between FIFO and LIFO matters less, but FIFO is fairly common practice. Tesla's throughput should be high enough, given the backorders it carries on its vehicles.

The second element is the lower-of-cost-or-market valuation rule. This policy recognizes that if goods carry a market value below cost, that lower figure is how those goods should be reflected on the balance sheet. This policy probably does not affect Tesla significantly given its current inventory throughput and the high resale value of its vehicles. However, for an automotive company that sells directly to consumers, this policy could have meaningful impacts in the future if Tesla ever finds itself carrying a significant finished-goods inventory.

The company must also conduct periodic inventory reviews to determine both what inventory it is holding and what the market value of that inventory is. This process is necessary in order to adequately value inventory and determine whether market value or book value is lower. Specifically, the company determines whether the selling price of the vehicles is lower than the cost to convert inventory into a finished product. If a car is expected to sell for less than it costs to make, the inventory will be valued at the final expected sale value, and a writedown will be required. This is particularly important for a young automotive company that may sell vehicles at a loss: the company will incur that loss in the year in which it occurs, creating a direct revenue impact from the inventory valuation policy if Tesla finds itself in that position.