Principal versus agent: reporting revenue gross or net

In this lesson you will

Identify the specified good or service provided to the end customer
Assess whether the entity controls that good or service before it transfers
Apply the three principal indicators as amended by ASU 2016-08
Explain the effect of the conclusion on revenue, cost of sales and margin

Why it matters

When another party is involved in providing goods or services to a customer, the entity determines whether its promise is to provide the specified goods or services itself (principal) or to arrange for the other party to provide them (agent). A principal reports revenue gross: the full amount billed to the customer, with the supplier cost in cost of sales. An agent reports revenue net: the fee or commission it keeps. Net income is the same either way, but revenue, gross margin percentages and any revenue-based covenants or earnouts change, sometimes by a factor of ten.

Step one: identify the specified good or service

ASU 2016-08 put the unit of account first. The entity identifies each specified good or service to be provided to the customer, which is a distinct good or service (or a distinct bundle). The specified item can be:

a good or another asset the entity obtains from the other party and then transfers;
a right to a service to be performed by the other party, which lets the entity direct that party to provide the service on its behalf; or
a good or service from the other party that the entity combines with other goods or services into the specified item, such as through a significant integration service.

These three cases, from 606-10-55-37A, describe what a principal obtains control of. A contract can have more than one specified good or service, and the entity can be a principal for some and an agent for others.

Step two: control before transfer

An entity is a principal if it controls the specified good or service before it is transferred to the customer (606-10-55-37). Legal title held only momentarily before passing to the customer does not by itself make the entity a principal. A principal can use a subcontractor and still be the principal.

The indicators

When control is not obvious, the entity uses indicators. As amended by ASU 2016-08, 606-10-55-39 lists three indicators that the entity controls the specified good or service (and is a principal):

Primary responsibility for fulfilling the promise, including the acceptability of the good or service (meeting customer specifications).
Inventory risk before the specified good or service has been transferred to the customer, or after transfer if the customer has a right of return. Buying stock before a customer order is strong evidence.
Discretion in establishing the price for the specified good or service.

ASU 2016-08 removed the old indicators about the form of consideration (commission) and credit risk. Credit risk does not tell you who controls the good. The indicators support the control assessment; they do not override it, and no single indicator is decisive.

Common patterns

Online marketplaces that list third-party sellers' goods, do not hold inventory and earn a fixed percentage are usually agents.
Staffing firms that hire workers, direct their work and bear the cost whether or not the client pays are usually principals for the staffing service.
Travel and ticket resellers that buy blocks of rooms or seats in advance at their own risk are usually principals for those items.
Shipping charged to customers follows the shipping and handling election and the analysis of who controls the delivery service.

Write down the specified good or service and the control evidence in the memo. The gross vs net guide and the staffing firm guide cover industry facts.

Taxes collected from customers

A related presentation issue: under the ASU 2016-12 election in 606-10-32-2A, an entity may exclude from the transaction price all sales, use, value added and some excise taxes that are imposed on and concurrent with a specific revenue transaction and collected from customers. Taxes on gross receipts and taxes imposed during inventory procurement are outside the election.

Worked example

An event company that resells hotel rooms

Keystone Events sells conference packages. Two arrangements:

Arrangement A: Keystone signs a contract with a hotel to buy 300 room nights at $150 each, nonrefundable, months before the event. It sets its own resale price of $210 and must pay the hotel whether or not rooms sell. Customers complain to Keystone about room problems, and Keystone resolves them.

Specified service: the right to a room night. Keystone obtains that right before the customer does and can direct the hotel to provide it to any attendee. Indicators: Keystone bears inventory risk (prepaid nonrefundable rooms), sets the price and handles acceptability. Principal. It sells 280 rooms: revenue $58,800, cost of sales $45,000 (all 300 rooms).

Arrangement B: for a second event, Keystone gives attendees a booking link to a hotel's own system. The hotel sets the rate, attendees pay the hotel, and Keystone earns a 10 percent commission. Keystone never controls a room. Agent. On $40,000 of bookings, revenue is $4,000.

Conclusion: two arrangements in one company produce gross revenue of $58,800 and net revenue of $4,000. The memo needs separate analyses.

Self-check

Answer each question before you open the answer.

What is the first step in a principal versus agent analysis after ASU 2016-08?
Show answer
Identify the specified good or service to be provided to the customer, then assess whether the entity controls it before it transfers to the customer.
Name the three indicators of control in 606-10-55-39 as amended.
Show answer
Primary responsibility for fulfilling the promise (including acceptability), inventory risk before transfer or after transfer on a return, and discretion in establishing the price.
Is the entity bearing credit risk an indicator of principal status after ASU 2016-08?
Show answer
No. ASU 2016-08 removed credit risk and the form of consideration from the indicators.
Does momentary legal title make an entity a principal?
Show answer
No. An entity that obtains legal title only momentarily before it passes to the customer is not necessarily a principal. The question is whether it controls the specified good or service.

Sources

Back to the syllabus

Standards are paraphrased from the primary sources listed above; read the source before relying on a requirement. This lesson is training material, not professional advice. Report an error