Gross vs Net Revenue Under ASC 606: Principal vs Agent Considerations With Examples

As an illustration, a company that sells $1,000,000 of goods and pays suppliers $850,000 reports either $1,000,000 of revenue and $850,000 of cost of sales, or $150,000 of revenue. Gross profit is the same. Revenue is not, and revenue drives covenants, growth metrics, valuation multiples, bonus plans and sometimes whether an entity crosses a size threshold.

The question is answered in ASC 606-10-55-36 through 55-40, the principal versus agent guidance, which the FASB clarified in ASU 2016-08. This guide explains the test, walks through examples, and sets out what auditors look for. For the broader model, see the ASC 606 guide and revenue recognition audit procedures.

The core question: control of the good or service

An entity is a principal if it controls the specified good or service before it is transferred to the customer. A principal reports revenue gross: the amount it is entitled to from the customer. An entity is an agent if its performance obligation is to arrange for another party to provide the specified good or service. An agent reports revenue net: the fee or commission it keeps.

The analysis is done for each specified good or service promised to the customer, not for the contract as a whole. One contract can have a principal element and an agent element. A travel company might be a principal for its own tours and an agent for third-party hotel bookings in the same transaction.

Step 1: identify the specified good or service

This is what is being provided to the end customer. Be specific. In a delivery marketplace, is the specified service the meal, the delivery, or access to a platform? The answer changes the conclusion. The specified good or service may also be a right to a good or service to be provided by another party, such as a ticket or voucher. The question is then whether the entity controls that right before it passes to the customer.

Step 2: determine whether the entity controls it before transfer

Control means the ability to direct the use of, and obtain substantially all the remaining benefits from, the good or service. The entity controls the good or service before it is transferred if it:

• obtains control of a good from another party before transferring it to the customer
• obtains a right to a service to be performed by another party, which gives it the ability to direct that party to provide the service to the customer on its behalf
• obtains control of a good or service from another party that it then combines with other goods or services into a specified, integrated good or service (a significant integration service)

Step 3: indicators of control

The standard lists indicators that may help the conclusion. They do not override the control principle, and they are not a checklist, but they are the practical working tool.

1. Primary responsibility for fulfillment. The entity is primarily responsible for fulfilling the promise to provide the good or service, including acceptability of the product. Who does the customer call when it goes wrong?
2. Inventory risk. The entity has inventory risk before the specified good is transferred, or after control transfers (for example, if the customer has a right of return). Obtaining, or committing to obtain, the good before having a customer contract points toward principal, but taking legal title only momentarily does not by itself mean the entity controls the good.
3. Discretion in establishing price. The entity has discretion in setting the price. Where the other party sets the price and the entity earns a fixed commission, that points to agent. Pricing discretion is not decisive on its own, because an agent can have some flexibility on price too.

Credit risk was once a listed indicator. The FASB removed it with ASU 2016-08, so a conclusion should not rest on it. Also, the fact that the entity receives a commission, or is paid only on completion, is not determinative on its own.

Examples

These are simplified. Real conclusions depend on contract terms and facts.

Example 1: reseller of equipment

A company buys equipment from a manufacturer, takes title, holds it in its warehouse, sets its own prices, invoices customers and handles warranty claims and returns. The company controls the equipment before transfer and has inventory risk, price discretion and primary responsibility. Principal, gross.

Example 2: drop-ship arrangement

The same company takes the order and sets the price, but the manufacturer ships directly to the customer. The company never touches the goods. Does it control them? Look at who is responsible for acceptability, whether the company can redirect the goods before shipment, who bears the risk of loss in transit and whether the company is liable if the supplier fails to ship. If the company is primarily responsible and sets the price, it can still be a principal even without physical possession. If the manufacturer is responsible and the company earns a fixed referral fee, it is an agent. Document the specific terms.

Example 3: online marketplace

A platform lists third-party sellers' products, collects payment from buyers and remits the amount less a commission. Sellers set prices, hold inventory and handle fulfillment and returns. The platform's specified service is arranging the sale. Agent, net: the commission is revenue. If the platform instead buys the goods, sets prices and handles returns, it would be a principal.

Example 4: travel arrangements

A travel company sells a package of flight and hotel. If it only arranges bookings and is paid a commission by the airline and hotel, it is an agent. If it contracts for rooms in advance, bears the risk on unsold rooms, sets the retail price and combines components into a package for which it is responsible, it is likely a principal.

Example 5: general contractor with subcontractors

A contractor subcontracts part of a project. The customer contracted with the contractor, the contractor is responsible for the overall project, directs the subcontractors and integrates their work into the final deliverable. The contractor controls the subcontracted services and integrates them, so principal, gross. A construction manager that merely coordinates, with owner direct contracts to subs and a fee, is an agent.

Example 6: freight brokerage

A broker sells shipping capacity to customers and pays carriers. If the broker is responsible for delivery, sets rates and takes on risk if a carrier fails, it is likely a principal. If it only matches shippers with carriers and the carrier is responsible, it is an agent.

Example 7: pass-through costs

An advertising agency buys media on behalf of clients. If the agency is responsible for media purchase, with the primary obligation to the media company, and has pricing discretion, gross is possible. If the media is purchased on the client's behalf and the agency earns a fee, net applies. The contract and who is liable to the media vendor matter.

Example 8: gift cards and software licenses

Selling third-party gift cards or licenses for another vendor's software raises the same questions: does the entity control the card or license before transfer? Look at who determines the price, who provides support, and who bears the risk of unsold items. A reseller that only arranges the sale, without controlling the license before it passes to the customer, is likely an agent.

Related policy elections that are not principal vs agent

• Sales taxes and similar taxes collected from customers for governmental authorities. A policy election allows entities to exclude them from the transaction price. This is distinct from the principal versus agent question and should be disclosed as a policy.
• Shipping and handling after control transfers. A policy election allows treating them as fulfillment costs.
• Reimbursable costs under contracts, such as pass-through travel costs. Analyze whether the entity is principal for those costs.

Presentation and disclosure

The income statement shows revenue gross or net based on the conclusion. Disclose the accounting policy and significant judgments. Where an entity has both types of arrangements, disaggregated revenue disclosures should be consistent with the conclusions. Use the GAAP disclosure checklist.

What auditors test

The conclusion is a judgment and a presentation risk that can change reported revenue materially. Under AU-C 315 and the fraud considerations of AU-C 240, consider incentives to grow top-line revenue. Presumed revenue fraud risk is part of the assessment, and gross-up is one way it shows up.

Understand the arrangements

• Obtain contract templates for each type of customer and supplier arrangement. Read for who sets price, who is responsible for fulfillment, who holds inventory and who bears liability.
• Inquire of sales, operations and legal about how the business actually works, and compare to the contract.
• Obtain management's accounting memo.

Evaluate the conclusion

• Evaluate the specified good or service, the control assessment and each indicator.
• Consider differences between contract and practice. For example, a contract says supplier is responsible, but the company's customer service handles all complaints and refunds.
• Evaluate consistency across similar arrangements.

Test amounts

• Select a sample of transactions and trace to customer invoices, supplier invoices and payments to check the amounts presented gross or net.
• Recompute revenue on a net basis for agent arrangements and agree to the commission.
• Test completeness of the population classified as agent revenue, and consider whether some of that revenue would be principal.
• Cutoff: see cutoff testing.
• Use analytical procedures on gross margin by product line, and investigate unexpected changes.

Disclosure

Check the policy note, significant judgments and disaggregation.

Document under AU-C 230.

Common issues

• Conclusion based on the label (the contract calls the company an agent) rather than control.
• Reliance on credit risk as an indicator.
• Mixed arrangements treated uniformly.
• Pass-through costs grossed up without analysis.
• No memo. The conclusion is habit.
• Change in contracts during the year without reassessment.

FAQ

What is the test for principal vs agent?

Whether the entity controls the specified good or service before it is transferred to the customer. If it does, it is a principal and reports revenue gross. If it arranges for another party to provide it, it is an agent and reports revenue net.

What indicators help decide?

Primary responsibility for fulfillment, inventory risk before or after transfer, and discretion in establishing price. They support, but do not replace, the control principle.

Is credit risk still an indicator?

No. ASU 2016-08 removed it from the list of indicators.

Can one contract have both principal and agent elements?

Yes. The assessment is made for each specified good or service in the contract.

Do sales taxes affect gross vs net?

Not as a principal vs agent matter. An entity can elect to exclude certain sales taxes collected from customers from the transaction price. This policy election is separate and should be disclosed.

Sources

• FASB ASC 606-10-55-36 through 55-40, Principal Versus Agent Considerations
• FASB ASC 606-10-25-25 (definition of control), 606-10-25-18B (shipping and handling election) and 606-10-32-2A (sales tax election)
• FASB ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)
• AICPA, AU-C Section 240, Consideration of Fraud in a Financial Statement Audit; AU-C Section 315; AU-C Section 230

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AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error