Principal versus agent considerations

Principal versus agent considerations – If an arrangement involves three or more parties, an entity will have to determine whether it is acting as a principal or an agent in order to determine the amount of revenue to which it is entitled. For example, technology entities may offer a platform to sell virtual or digital goods on behalf of a third party or they may contract with an advertising agency to deliver advertising content to a website or mobile application.

When the entity is the principal in the contract, the revenue recognised is the gross amount (i.e., the amount to which the entity expects to be entitled as the principal). When the entity is the agent, the revenue recognised is the net amount (i.e., the amount to which the entity is entitled in return for its services as the agent).

A principal’s performance obligations in a contract differ from those of an agent. IFRS 15 notes that a principal controls the goods or services before they are transferred to the customer. Consequently, the principal’s performance obligation is to transfer the goods and services to the customer.

However, an entity that momentarily obtains legal title of a product before legal title is transferred to the customer is not necessarily acting as a principal. In contrast, an agent does not control the goods or services before they are transferred to a customer. The agent is simply facilitating the sale of goods or services to the customer in exchange for a fee or commission. Therefore, the agent’s performance obligation is to arrange for another party to provide the goods or services to the customer.

Principal versus agent considerations Entities may find it difficult to determine which party controls an intangible good or service prior to its transfer to the customer. In addition, it is not always clear which party is the customer. For example, for an online game developer, the customer may be the intermediary that provides the social networking platform or it may be the end-customer.

Depending on an entity’s conclusion, the amount and timing of revenue recognised could differ significantly. Principal versus agent considerations

As noted in IFRS 15, for the entity to conclude it is acting as the principal in the arrangement, it must determine that it controls the goods or services promised to the customer before those goods and services are transferred to the customer. Because this determination is not always clear, IFRS 15 provides indicators to assist the entity in making it.

The indicators in IFRS 15 reflect concepts such as identifying performance obligations and the transfer of control of goods or services. Principal versus agent considerations

Appropriately identifying the entity’s performance obligation in a contract is fundamental to the determination of whether the entity is acting as a principal or an agent.

Judgement will be required to apply the indicators to intangible goods or services because they have been written in respect of tangible goods. There may be additional complexity if the entity does not know the gross amount charged to the end-customer. That might be the case when an intermediary contracts directly with the end-customer and the intermediary pays the entity its portion of the consideration under the arrangement, but does not provide full details of its transaction with the end-customer. Principal versus agent considerations

TRG Discussions

Principal vs. Agent (Agenda Paper 1; July 2014 and Clarifications to IFRS 15)

In connection with the guidance set out above, the TRG discussed a number of issues regarding Paragraphs B34-B38 (Principal vs Agent considerations).

Some stakeholders questioned whether control is always the basis for determining whether an entity is a principal or an agent, and how the control principle and the indicators in Paragraph B37 work together. Other stakeholders questioned how to apply the control principle to contracts involving intangible goods or services.

As a consequence of this, the IASB issued Clarifications to IFRS 15 in April 2016 to clarify the application of the control principle. It amended Paragraphs B34-B38 of IFRS 15, Examples 45-48 accompanying IFRS 15 and added Examples 46A and Example 48A. The FASB reached the same decisions as the IASB regarding the application of the control principle when assessing whether an entity is a principal or an agent.

The TRG discussed at its July 2014 meeting whether certain types of billing to customers should be accounted for as revenues:

  • Shipping and handling fees; Principal versus agent considerations
  • Reimbursements of other out-of-pocket expenses; Principal versus agent considerations
  • Taxes collected from customers. Principal versus agent considerations

TRG members noted that the revenue standard provides sufficient guidance about determining the appropriate presentation of amounts billed to customers and that an entity would therefore record the gross amount received from a customer unless the entity is only collecting amounts on behalf of third parties. It is necessary to consider the principal and agent guidance to help determine how to present these types of billings.

Shipping and handling fees (Agenda Paper 2; July 2014 and Amendments to Topic 606)

Some stakeholders in the US have expressed differing views about whether and when shipping and handling activities that occur after the transfer of control to the customer should be accounted for as a promised service or as a fulfilment activity.

The FASB has made an amendment to Topic 606 to state explicitly that an entity is permitted (as an accounting policy choice) to account for shipping and handling activities that occur before the customer obtains control of the related good as fulfilment activities. The IASB has not made a similar amendment in order to avoid creating an exception to the revenue recognition model.

Taxes (Agenda Paper 2; July 2014 and Clarifications to IFRS 15)

Due to the concerns expressed by some US stakeholders about the cost and complexity of assessing tax laws in each jurisdiction, the FASB decided to permit entities an accounting policy choice either to include or exclude from the measurement of the transaction price all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction and collected from customers (for example, sales, use or value added taxes).

The IASB has decided not to provide a similar accounting policy choice under IFRS 15 and, consistent with current standards, sales taxes included in the amounts charged to customers that are collected on behalf of governments are excluded from the transaction price in Step 3.

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