United States

Revenue recognition: FASB revises new principal vs. agent guidance

INSIGHT ARTICLE  | 

On March 17, 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). This ASU revises the principal vs. agent guidance originally included in ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This summary provides: (a) background information on ASU 2014-09 and the process in place to address issues that have arisen in practice with respect to its implementation and (b) an overview of the revised principal vs. agent guidance in Topic 606 of the FASB’s Accounting Standards Codification (ASC).

Background

In May 2014, the FASB and International Accounting Standards Board (IASB) issued substantially converged revenue recognition standards. The new guidance provides a comprehensive revenue recognition model that replaces virtually all existing revenue recognition guidance in U.S. generally accepted accounting principles and International Financial Reporting Standards. 

To help address issues identified by entities as they implement the new guidance, the FASB and IASB established the Joint Transition Resource Group (TRG). The TRG has met several times since the new guidance was issued and the FASB and IASB have added projects to their agendas to address several of the TRG issues that they believe warrant additional standard setting. While there are some issues where the FASB and IASB are moving in lockstep, there are also several issues where that is not the case. Fortunately, the FASB and IASB have moved in lockstep to address issues related to applying the new principal vs. agent guidance (i.e., reporting revenue gross vs. net). While the IASB has not yet issued its final revisions to address these issues, they are expected to issue final revisions in the near future that are consistent with the revisions made by the FASB in ASU 2016-08. If that is the case, convergence of the principal vs. agent guidance will be maintained.  

The new guidance in ASC 606, including the revisions made by ASU 2016-08, is effective in the quarter and year beginning January 1, 2018, for public entities with a calendar year-end. For all other entities with a calendar year-end, the new guidance is effective in the year ending December 31, 2019, and interim periods in 2020. 

Additional revisions to the new guidance are in the process of being made by the FASB. For a complete list of all of the pending and finalized revisions to the new guidance, refer to our summary, Revenue recognition: In motion. For information about the revisions being made by the IASB, refer to the IASB’s website.

Overview of revised principal vs. agent guidance

The principal vs. agent guidance in ASC 606 is only applied when another party is involved with the entity in providing the specified goods or services to the customer. For instance, in Example 46 (starting at ASC 606-10-55-320), the reporting entity enters into: (a) a contract with a customer for specialized equipment and (b) a contract with a supplier to manufacture the equipment to the specifications provided by the reporting entity. In this example, the principal vs. agent guidance must be considered due to the supplier’s involvement in providing the specialized equipment to the customer. If the reporting entity manufactured the specialized equipment itself, the principal vs. agent guidance would not be considered.

When another party (e.g., a supplier) is involved in providing goods or services to a customer, there are two key steps in the principal vs. agent guidance in ASC 606:

  • Identifying the specified goods or services being provided to the customer
  • Determining whether the entity obtains control of the specified goods or services before transferring control of those goods or services to the customer 

Additional information about each of these steps is provided in the remainder of this summary.

Identifying the specified goods or services

Identifying the specified goods or services being provided to the customer takes place in the second step of the new revenue recognition model, which is to identify the performance obligations in the contract:

Identifying the performance obligations in the contract establishes the units of account to which the remaining steps of the revenue recognition model must be applied. The same analysis used to identify the performance obligations is also used to identify the specified goods or services to which the principal vs. agent guidance is applied when another party is involved in providing those goods or services to the customer. The remainder of this summary will focus on identifying specified goods or services and analyzing them under the principal vs. agent guidance. For additional information about identifying performance obligations and applying the remaining steps in the revenue recognition model to a performance obligation, refer to our white paper, Revenue recognition: A whole new world.

The first step in identifying the specified goods or services in the contract is to identify all of the promises to provide goods or services in the contract. Understanding the nature of the entity’s promise when another party is involved in providing the promised goods or services to the customer is very important because it sets the stage for determining whether the entity obtains control over those promised goods or services before they are transferred to the customer. For instance, in Example 47 (starting at ASC 606-10-55-325), the reporting entity buys airplane tickets from major airlines and sells those tickets to consumers. Based on the facts and circumstances in this example, the promised good or service is the right to fly on a specific flight and not the flight itself. The analysis to determine whether the reporting entity obtains control over the right to fly on a specific flight would be different from the analysis to determine whether the reporting entity obtains control over the flight itself. Moreover, these different analyses could produce different conclusions with respect to whether the reporting entity is acting as a principal or an agent.   

Under the second step in identifying the specified goods or services in the contract, the guidance in ASC 606-10-25-19 through 22 is applied to determine whether the promises to provide goods or services are distinct. If a promise to provide a good or service is distinct, it is considered a specified good or service to which the principal vs. agent guidance is applied. If a promise to provide a good or service is not distinct, it is combined with one or more other promises to provide goods or services until the combined group is considered distinct. Each distinct group of promised goods or services is considered a specified good or service to which the principal vs. agent guidance is applied. 

If a contract includes multiple specified goods or services, the entity may be a principal with respect to some specified goods or services and an agent with respect to other specified goods or services, depending on the facts and circumstances. For instance, in Example 48A (starting at ASC 606-10-55-334A), the reporting entity agrees to provide a customer with a suite of recruiting services to fill open job positions and facilitates the customer obtaining a license to a third-party database with information about potential recruits. Based on the facts and circumstances in that example, the reporting entity concludes it is a principal with respect to the recruiting services and an agent with respect to the third-party database license.

Determining whether control of a specified good or service is obtained

Once the specified goods or services have been identified, the entity must determine whether it controls each of the specified goods or services before it is transferred to the customer. If so, the entity is acting as a principal and should include the gross amount of consideration related to each of the specified goods or services in the transaction price (which is the amount ultimately recognized as revenue). If not, the entity is acting as an agent and should include the net fee or commission it expects to be entitled to for arranging to have another party provide the specified good or service to the customer in the transaction price.  

When another party is involved with the entity in providing the goods or services that make up a specified good or service to the customer, the entity is a principal with respect to the specified good or service in the following situations:    

  • The entity obtains control of a good or another asset from the other party and then transfers that good or other asset to the customer. Example 45 (starting at ASC 606-10-55-317) involves a reporting entity operating a website that customers may use to buy products from a variety of suppliers. In that example, to conclude it is a principal with respect to the product sales, the reporting entity must obtain control of the products ordered by the customers before it transfers control of the products to the customers. 
  • The entity obtains control of a right to a service from the other party and has the ability to direct the other party in providing the service to the customer on the entity’s behalf. Example 46A (starting at ASC 606-10-55-324A) involves a reporting entity entering into: (a) a contract with a customer for maintenance services and (b) a contract with a supplier to provide maintenance services to the customer. In that example, to conclude it is the principal with respect to providing maintenance services, the reporting entity must have the ability to direct the supplier in providing the maintenance services to the customer on the reporting entity’s behalf. 
  • The entity obtains control of a good or service from the other party that the entity then combines with other goods or services to provide the specified good or service to the customer. When the entity obtains a good or service from the other entity that is not distinct on its own, but that is used by the entity in combination with other goods and services (e.g., integration services) to provide a distinct good or service (i.e., a specified good or service) to the customer, the entity is the principal with respect to that specified good or service. For instance, in Example 46 (starting at ASC 606-10-55-320), a reporting entity enters into: (a) a contract with a customer for specialized equipment and (b) a contract with a supplier to manufacture the equipment to the specifications provided by the reporting entity. In that example, the reporting entity must consider whether manufacturing the equipment (i.e., the good or service provided by the other party) is distinct from the other goods and services provided by the reporting entity to produce the specialized equipment (e.g., services to design the specialized equipment). If manufacturing the equipment is distinct, then there is more than one specified good or service in the contract and the reporting entity would need to determine whether it is the principal with respect to each of those specified goods or services. If manufacturing the equipment is not distinct, the specified good or service is the specialized equipment and the reporting entity is the principal with respect to providing that equipment to the customer.     

For purposes of assessing whether the entity obtains control of the good, other asset, service and (or) right to a service that make up the specified good or service in these situations, the entity should consider whether it has the ability to direct the use of the specified good or service and receive substantially all of the related remaining benefits (which includes the entity being able to stop others from directing the use of the specified good or service and receiving substantially all of the related remaining benefits). This approach to determining whether the entity has control of the specified good or service before it is transferred to the customer is the same approach used to determine whether control of the goods or services underlying a performance obligation has transferred to the customer for purposes of recognizing revenue. 

In some cases, an analysis of the facts and circumstances will conclusively show that the entity has the ability to direct the use of the specified good or service and receive substantially all of the related remaining benefits. For instance, in Example 46, the analysis as to whether the reporting entity controlled the specialized equipment before it was transferred to the customer was conclusive in and of itself, and no further analysis was required. In other situations in which the analysis of the facts and circumstances does not conclusively show that the entity has the ability to direct the use of the specified good or service and receive substantially all of the remaining benefits, the entity may consider the following indicators:

  • Primary responsibility for fulfillment. If the entity (and not the supplier) is primarily responsible to the customer for fulfillment of the specified good or service, then that supports the entity obtaining control of the specified good or service before it is transferred to the customer. Having primary responsibility for fulfillment typically involves being responsible for the acceptability of the specified good or service (e.g., being responsible for the specified good or service meeting customer specifications).
  • Inventory risk. If the entity has inventory risk before or after the specified good or service is transferred to the customer, then that supports the entity obtaining control of the specified good or service before it is transferred to the customer. The nature of the inventory risk should be considered in assessing the weight this indicator should carry in the overall evaluation of whether the entity has obtained control of the specified good or service. For example, legal title to inventory briefly passing to the entity before it passes to the customer should carry little, if any, weight in the overall evaluation. Conversely, the entity obtaining inventory, or committing to obtain inventory, before it enters into the customer contract to sell the inventory should carry more weight in the overall evaluation. 
  • Discretion in setting prices. If the entity (and not the supplier) has discretion in setting the price paid by the customer for the specified good or service, then that may support the entity obtaining control of the specified good or service before it is transferred to the customer. However, it is not uncommon for an agent to have discretion in setting the price paid by the customer. 

With respect to using these indicators in the overall evaluation of whether the entity obtains control of a specified good or service, the FASB indicated the following in paragraph BC16 of ASU 2016-08:  

The indicators (a) do not override the assessment of control, (b) should not be viewed in isolation, (c) do not constitute a separate or additional evaluation, and (d) should not be considered a checklist of criteria to be met in all scenarios. Considering one or more of the indicators often will be helpful, and, depending on the facts and circumstances, individual indicators will be more or less relevant or persuasive to the assessment of control.

The views expressed by the FASB in paragraph BC16 underscore the overriding question in determining whether the entity is acting as a principal (and should ultimately recognize revenue gross) or an agent (and should ultimately recognize revenue net) with respect to providing the specified good or service to the customer—does the entity obtain control of the specified good or service before it is transferred to the customer? Example 47 (starting at ASC 606-10-55-325) and Example 48 (starting at ASC 606-10-55-330) illustrate how different facts and circumstances related to similar specified goods or services (a right to fly on a specific flight and a right to a meal at a specific restaurant, respectively) can result in opposite conclusions with respect to this question. Comparing and contrasting these examples may be insightful in understanding how to determine whether an entity controls a specified good or service before it is transferred to the customer.

AUTHORS


How can we help you?

To discuss how our team can help your business, contact us by phone 800.274.3978 or

EMAIL US