Revenue Recognition: Acting as a Principal or an Agent?

The distinction between the role an entity plays as an agent or principal has significant consequences on the recognition and presentation of revenue in the financial statements. Entities often get confused whether to recognise revenue on a gross or net basis. Acting as a principal would require revenue recognition on a gross basis. In other words, the full revenue and the full related expenses would be recognised in profit or loss. Recognising revenue on a net basis, i.e., offsetting the revenue and the related expenses, would suggest the entity is acting as an agent. Sometimes entities are not even aware that an assessment has to be performed.

Significant judgement is often required to determine which role an entity has in the contractual agreement for a good or service. In those instances, an entity should disclose the significant judgements made on the assessment.

The overarching concept in a principal vs. agent analysis is always control, consistent with the overall principles of IFRS 15 Revenue from Contracts with Customers (“IFRS 15”). For example, an entity cannot provide a good or service to a customer that it doesn’t control before the revenue generating transaction takes place. When the entity controls the goods or service, it is acting as the principal. If it doesn’t, the entity is acting as an agent.

When assessing a principal vs. agent relationship there is no ‘one size fits all’, each and every circumstance must be considered on its own. That is, for each promised good or service within a contract, an entity should assess whether it is an agent or a principal. One contract with a customer could result in the entity acting as an agent for one service and a principal for another service. To report useful information to the users of financial statements about the nature and amount of revenue arising from contracts with customers, thorough application of the principles must be performed. The principles should not be considered in isolation.

Provision of the specified good or service by the entity itself.Providing the specified good or service on behalf of another party.
Controls the good or service before providing it to the customer.Does not control the good or service before it is provided to the customer.
Gross revenue recognition Net revenue recognition

A common mistake that entities make in assessing whether an entity is an agent or a principal relationship, is the consideration of who is exposed to credit risk. Exposure to credit risk is no longer considered relevant when evaluating contracts within the scope of IFRS 15. The IASB found that credit risk is generally not a helpful indicator when assessing whether or not an entity controls a good or service. As such, the credit risk consideration should not be assessed as part of the principal vs. agent analysis.

IFRS 15 provides a list of indicators that would support control by an entity in paragraph B37; however, control assessment is not limited to the indicators below:

Table 2: Summary of control indicators

Indicators of control of the specified goods or services before transfer to the customer
Primary responsibility for fulfilment of the promised good or service.
Exposure to inventory risk before and/or after transfer of control to the customer on the specified good or service.
Discretion in price establishment, however, an agent can also have the discretion at times.

These indicators do not override the control analysis, but it is meant to support the control analysis. 

An example:

An entity (A) is involved in the rendering of asset management services to customers. The services performed include investment of monies from customers in another entity (B). The customer is directly entitled to the benefits as the asset managers invest the money and bear the related risks in cases of the downside in the market. Entity A does not bear the risks when the customers lose money as they do not control the monies invested by the customers. The asset managers do not have control over the market movements nor how much the customer decides to invest. They are only entitled to a commission earned based on services performed, in this case, entity A is acting as an agent on behalf of the customer and should only recognise revenue on a net basis, being the commission earned.

In cases where management is not reasonably certain of the accuracy of their conclusions, a consultation with an IFRS specialist should be considered. Similarly, auditors have to perform their own assessment of the accuracy of management’s conclusions, in situations where the auditors require assistance with the assessment, consultation with an IFRS specialist should be considered.