Chapter 10 — Principal-Versus-Agent Considerations

10.2 Determining Whether an Entity Is Acting as a Principal

The revenue standard’s core principle focuses on the transfer of control of goods or services to a customer. When developing the framework for evaluating whether an entity’s performance obligation is to transfer goods or services to a customer or to arrange for another party to provide those goods or services to a customer, the FASB and IASB observed that an entity would be a principal if it controlled those goods or services before they were transferred to the customer. This observation is reflected in the following guidance:

ASC 606-10

55-37 An entity is a principal if it controls the specified good or service before that good or service is transferred to a customer. However, an entity does not necessarily control a specified good if the entity obtains legal title to that good only momentarily before legal title is transferred to a customer. An entity that is a principal may satisfy its performance obligation to provide the specified good or service itself or it may engage another party (for example, a subcontractor) to satisfy some or all of the performance obligation on its behalf.

55-37A When another party is involved in providing goods or services to a customer, an entity that is a principal obtains control of any one of the following:

A good or another asset from the other party that it then transfers to the customer.
A right to a service to be performed by the other party, which gives the entity the ability to direct that party to provide the service to the customer on the entity’s behalf.
A good or service from the other party that it then combines with other goods or services in providing the specified good or service to the customer. For example, if an entity provides a significant service of integrating goods or services (see paragraph 606-10-25-21(a)) provided by another party into the specified good or service for which the customer has contracted, the entity controls the specified good or service before that good or service is transferred to the customer. This is because the entity first obtains control of the inputs to the specified good or service (which include goods or services from other parties) and directs their use to create the combined output that is the specified good or service.

10.2.1 Controlling a Good Before Transferring It to a Customer

Often, it will be clear that an entity controls a good before it is transferred to a customer because the entity acquired the good (i.e., obtained control) from a third party before transfer of the good to the customer. These situations will often involve an element of inventory risk that is assumed while the good is in the entity’s control.

For example, an online clothing retailer obtains physical possession of goods (inventory) from its designers and stores the goods in its warehouse. The retailer separately enters into contracts with customers to sell goods held in its warehouse. In this example, it is clear that the retailer controls the goods before transferring them to the customer.

However, other scenarios may not be as clear. Consider a situation in which an online retailer holds some goods (inventory) in its warehouse but also has arrangements with some of its suppliers that allow it to direct the supplier to ship certain goods directly from the supplier’s warehouse to the end customer (i.e., it does not have inventory risk for all goods). This sort of an arrangement would have to be evaluated more carefully, as illustrated below.

Example 10-1

An electronics retailer has physical locations but also sells goods to its customers through its Web site. Customers can choose to purchase goods at the retailer’s physical location but can purchase the same goods online. The retailer has full discretion in determining the price of the goods and generally offers the same price in stores as it does online. Customers who choose to buy electronics online enter into a contract with the retailer to purchase one or more specified goods. The retailer can satisfy its obligation to transfer a specified good to a customer either by shipping the good from one of its physical locations or by directing its supplier to ship the good from the supplier’s warehouse. If the retailer directs its supplier to ship the good directly to the customer, the retailer will take title to the specific good only momentarily before title passes to the customer upon shipment. The retailer is required to pay the supplier for the good even if it does not receive payment from the customer. If the customer is not satisfied with the good or there is a defect, the customer can return the good to one of the retailer’s physical locations.

In this case, because the retailer takes title to the good only momentarily before passing title on to the customer, it may not be clear whether the retailer controls the specified good before the good is transferred to the customer. That is, further consideration is required. However, the retailer may conclude that it controls the good before the good is transferred to the customer because it has the ability to direct the use of, and obtain substantially all of the remaining benefits from, the good (i.e., it directs the supplier to ship the good to the retailer’s customer). In addition, after considering the control indicators discussed below, the retailer concludes that it is the principal because it is primarily responsible for satisfying the performance obligation, it has some inventory risk upon product return, and it has latitude to establish pricing — factors that further indicate that it controls the good before the good is transferred to the customer. Therefore, the retailer concludes that it should record revenue on a gross basis.

The example above is similar to a fact pattern discussed in a speech at the 2018 AICPA Conference on Current SEC and PCAOB Developments by Sheri York, then professional accounting fellow in the OCA. In her speech, Ms. York made the following observations related to the determination of whether an entity is a principal or an agent when the entity never obtains physical possession of the specified good:

Application of the principal versus agent guidance can be especially challenging when an entity never obtains physical possession of a good (for example, when goods are shipped directly from a manufacturer to the third party). Over the past year OCA has received questions regarding the principal versus agent determination in these types of fact patterns, including fact patterns where the company concluded it was acting as a principal and others where the company concluded it was acting as an agent. I would like to share one of the consultations that OCA received on this topic.

In this consultation, the registrant distributed a wide variety of healthcare-related goods to retailers. The registrant maintained inventory for the majority of the goods sold; however, for certain specialized goods, the manufacturer shipped the goods directly to the retailer. The registrant managed the return process with the retailer; however, due to regulatory reasons, certain returned goods were returned directly to the manufacturer.

The registrant concluded that it was acting as a principal in the arrangement because it controlled the specified good before it was transferred to the customer. That is, the registrant had the ability to direct the use of, and obtain substantially all of the remaining benefits from, the goods. As part of its assessment of control, the registrant considered the indicators of control and concluded that it was primarily responsible for fulfillment and had discretion in establishing the price at which the goods were sold to the retailer. The registrant believed that it was primarily responsible for fulfillment based on the terms of the agreement and marketing materials communicated to the customer. In this fact pattern, the registrant was the primary point of contract with the retailer, and was contractually responsible for ensuring that products were acceptable to the retailer, including responsibility for issues related to delivery, quantity, and spoilage.

In this fact pattern, the staff did not object to the registrant’s conclusion that it was the principal in the transaction. Based on my experience, I think it is important to remember that the conclusion as to whether or not an entity is a principal or an agent requires a consideration of the definition of control, often including consideration of the indicators of control, of which inventory risk is only one of the possible indicators. In some circumstances, physical possession will not coincide with control of a specified good. [Footnotes omitted]

Typically, the principal in a transaction to sell goods to its customer will have legal title to the goods before they are transferred to the customer. However, ASC 606-10-55-37 states, in part, that “an entity does not necessarily control a specified good if the entity obtains legal title to that good only momentarily before legal title is transferred to a customer.” Nevertheless, we do not believe that having legal title only momentarily (e.g., flash title) automatically precludes the entity from having control of the goods before they are transferred to the customer. Accordingly, the entity will need to perform a thorough analysis of the overall definition of control and the other indicators in ASC 606-10-25-30 and ASC 606-10-55-39 to determine whether it has the ability to control the goods before they are transferred to the customer.

The example below considers whether an entity’s momentary legal title to goods that the entity sells to an end customer automatically precludes a determination that the entity (1) has control of the goods before selling them to the end customer and (2) is therefore the principal in the transaction.

Example 10-2

Company L, the owner and operator of retail stores that sell clothing and accessories to customers, enters into contracts with clothing manufacturers to purchase clothing that is based on L’s specifications. Upon receiving a purchase order from L, a manufacturer produces the clothing and ships it to L’s warehouse. Company L subsequently delivers the clothing to its individual retail stores for sale to end consumers. At its own discretion, L will direct the use of the clothing by specifying the stores to which the clothing is to be delivered.

The manufacturer retains legal title to the clothing until L sells the clothing to an end consumer. Upon L’s sale of the clothing to the end consumer, legal title is transferred only momentarily to L and then is immediately transferred from L to the end consumer (i.e., flash title transfer). Consequently, L has physical possession of the clothing but has legal title to the clothing only momentarily before selling it to the end consumer. However, L can obtain the economic benefits of the clothing because it has the unilateral ability to sell the clothing to an end consumer despite having legal title to the clothing only momentarily before the sale. In addition, the manufacturer does not have the ability to recall the clothing or direct it to another retailer once it has been shipped to L. Further, L is not obligated to pay the manufacturer for any clothing purchased until such clothing is sold to the end consumer.

We do not believe that having legal title to the clothing only momentarily automatically precludes L from having control of the clothing. To be considered a principal in a transaction, an entity must have control of the specified good or service before transferring that good or service to a customer, as stated in ASC 606-10-55-37. Legal title is one of the indicators of control in ASC 606-10-25-30, but that indicator alone is not determinative of whether an entity has control of an asset. As indicated in ASC 606-10-25-30(b) and discussed in Section 8.6.4.1, there are circumstances in which control of an asset can be transferred to the customer even though the seller retains legal title to the asset until the asset is sold to the end consumer. In the fact pattern outlined above, L must consider the overall definition of control and the other indicators in ASC 606-10-25-30 and ASC 606-10-55-39 to determine whether it obtains control of the clothing without taking legal title to the clothing.

ASC 606-10-25-25 states, in part:

Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. Control includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset.

Under the facts of this example, L has the ability to direct the use of the clothing by delivering the clothing to L’s individual retail stores for resale to end consumers. Further, L can obtain the remaining benefits from the clothing by selling it to end consumers. Although the manufacturer retains legal title to the clothing until it is sold, the manufacturer does not have the ability to prevent L from directing the clothing to L’s retail stores and selling the clothing to end consumers. Therefore, notwithstanding that L has legal title to the clothing only momentarily and is not obligated to pay the manufacturer for the clothing until the clothing is sold to the end consumer, L controls the clothing as the principal in the transaction in the absence of any indicators under ASC 606-10-55-39 to the contrary.

The definition of control also includes the ability to “obtain substantially all of the remaining benefits from” the asset. However, even if an entity earns a fixed commission upon reselling a good, the entity can still control the good before it is transferred to a customer. In a speech at the 2020 AICPA Conference on Current SEC and PCAOB Developments, Jillian Pearce, then professional accounting fellow in the OCA, discussed a fact pattern in which a commodity reseller was a principal in its arrangements to sell commodity produced by a related party. In her speech, Ms. Pearce commented as follows on the determination of whether an entity is a principal or an agent when the entity earns a fixed percentage commission:

I would like to share observations on a fact pattern involving a registrant that produces and sells a commodity to its customers. In this fact pattern, the registrant had the contractual right to market and sell 100 percent of the commodity produced by a related party.

The registrant determined how to source the commodity to fulfill its contracts with customers — either from its own production, from production from the related party facility, or from a third party. This raises the issue of whether the registrant was acting as a principal or an agent in selling the commodity produced by the related party. If the registrant sourced the product from the related party facility, the registrant took possession and legal title of the product and transported it to the customer. The registrant had the right to redirect the product to different customers during transportation, subject to certain geographic restrictions, but the registrant believed inventory risk was mitigated by an insurance policy that covered risk of damage or loss. The selling price of the commodity was generally determined based on the market price of the product at the time of delivery. For product sourced from the related party facility, the registrant received payment from the end customer and remitted payment to the producer, less a fixed percentage commission that the registrant retained.

The registrant proposed to account for the commodity sales from this producer on a net basis, as it determined it was acting as an agent in the sale of the commodity from the producer and did not believe it controlled the product. The registrant evaluated the indicators of control outlined within the revenue standard. While it did not believe any of the indicators were determinative, the registrant ultimately concluded it was an agent in the transaction as it did not receive substantially all of the benefits from the sale of the commodity as a result of its fixed percentage commission.

OCA staff objected to the registrant’s conclusion that it did not have the right to direct the use of and obtain substantially all of the remaining benefits of the product from the producer, and therefore concluded the registrant was the principal in the transaction based on the total mix of information presented. [Footnote omitted]

10.2.2 Controlling the Right to a Service

There may also be instances in which an entity controls a right to a service (e.g., a voucher or ticket) and passes it on to a customer. In these instances, the entity is not providing the service to which the voucher entitles a customer, but the entity may control the right to the service by controlling the voucher (e.g., prepurchasing the voucher) before it is transferred to the customer. The entity can redeem the voucher for the service, or it can transfer the right to the service to a customer by transferring the voucher. In addition, an entity may control the right to a service if it directs the service provider to perform the service on the entity’s behalf for any of the entity’s customers.

Example 10-3

Entity A enters into a management agreement with Customer B to provide lawn maintenance services, including fertilization, mowing and trimming, and periodic seeding. Entity A does not provide lawn maintenance services itself; rather, it contracts with third-party service providers for each aspect of the lawn maintenance service. Entity A and Customer B have agreed on a single price for the lawn maintenance service.

Entity A separately enters into contracts with third-party service providers and directs those service providers to perform each aspect of the lawn maintenance services. Once A enters into contracts with the third-party service providers, it can direct those service providers to perform services on A’s behalf for any number of its customers.

Even though A is not performing the services, it controls the right to the services by directing specific lawn maintenance service providers to perform each aspect of the lawn maintenance services. Because A controls the right to the services, A concludes that it is acting as the principal.

The example above has similarities to a fact pattern discussed by Lauren Alexander, professional accounting fellow in the OCA, in a speech at the 2019 AICPA Conference on Current SEC and PCAOB Developments. In her speech, Ms. Alexander made the following observations related to the determination of whether an entity is a principal or an agent in a contract to provide specified services to a customer:

Determining whether an entity is a principal or an agent in a revenue transaction can be particularly challenging when two parties are involved in providing services to a customer, especially if some of the services can only be provided by a specific service provider.

In the consultation that I will discuss today, the registrant entered into contracts with customers to provide several related services in exchange for a fee. The contracts acknowledged that another service provider would provide some of the services, and the services were marketed to customers using the brand names of both the registrant and the other service provider. The registrant sought the staff’s view on whether it was a principal or an agent in the revenue transaction.

The registrant noted that some of the services promised in the contract were based on its proprietary content, and that it was heavily involved in providing those services to the customer, with limited involvement from the other service provider. However, due to certain regulatory restrictions, the registrant could not legally provide some of the services promised in the contract and therefore had to rely entirely on the other service provider to deliver those services.

The registrant concluded that it was the principal in the transaction for each of the specified services and should record revenue on a gross basis because it controlled the services before transferring them to the customer. In reaching this conclusion, the registrant stated that it had the contractual ability to direct the other service provider to provide services to customers on its behalf, and customers did not have contractual relationships with the other service provider. The registrant asserted that it was primarily responsible for fulfilling the promise to provide the specified services.

However, the registrant noted that it only had the right to dictate certain general parameters about the services to be provided by the other service provider, and that the other service provider had discretion in determining exactly how to fulfill its obligation. The registrant said that it controlled when the other service provider delivered the services, and that contractually the other service provider did not have the right to deny services to customers. Finally, the registrant was responsible for handling most customer concerns that arose from the services provided by the other service provider.

In this fact pattern, the staff did not object to the registrant’s conclusion that it was the principal in the transaction and should record revenue on a gross basis. The staff observed that the registrant could control the specified services by entering into a contract with another service provider in which the registrant defined the scope of services to be performed on its behalf, even if the registrant could not fulfill the contract using its own resources (that is, it could not legally provide certain of the services promised in the contract).

As discussed in previous staff speeches, we continue to observe that applying the principal versus agent guidance may require significant judgment, especially in the case of emerging business models. We encourage registrants to carefully consider their specific facts and circumstances and contractual terms, and any changes to these terms over time, when applying this guidance. [Footnotes omitted]

10.2.2.1 Control Over Employees — Professional Services Organizations and Employers of Record

Professional services organizations (PSOs) may provide temporary workforce or recruiting services. Sometimes, it may be clear that the nature of the entity’s promise is to provide a workforce (e.g., a customer contracts with the entity for temporary labor, and the entity is primarily responsible for providing the workforce). In these instances, the entity (1) will make all hiring and firing decisions, (2) will determine employee wages and benefits, (3) will supervise and manage employees, and (4) can redeploy employees at its discretion. Under these circumstances, an entity may reasonably conclude that it is the principal in the arrangement (i.e., it controls the employees) and that it should therefore report any consideration received from the customer (including the consideration related to the employees’ wages) as revenue on a gross basis. However, in other situations, the nature of the entity’s promise might be to arrange for employees to provide services to a customer (e.g., the entity is the legal employer of record [EOR] but does not control the employees).1

Example 10-4

Entity JW is a PSO that provides EOR services, which allow its customers to hire and deploy professionals without having a legal footprint in the jurisdiction(s) in which the professionals are working. Customers identify specific professionals to be employed; determine the professionals’ salaries, bonuses, and benefits; supervise and manage the professionals; and determine when and what work the professionals will perform. As the legal EOR, JW performs all payroll processes and payment services as well as tax compliance filings and remittances. Entity JW is required to pay the professionals’ salaries, bonuses, and benefits (in amounts determined by the customers), and JW is entitled to recover from its customers any amounts paid to professionals. If a professional who is performing work for a customer quits or is fired, JW is not responsible for identifying and employing a different professional. Rather, the customer, at its sole discretion, will identify another professional to be employed by JW. In addition, JW is not responsible for the quality of the services provided by professionals. In exchange for providing the EOR services, JW charges customers a fee based on a percentage of the employees’ salaries and bonuses.

Entity JW concludes that the nature of its promise is to arrange for each professional to provide services directly to a customer of JW. Although JW is the legal employer of the professional, JW concludes that it does not obtain control of the professional’s services before they are transferred to the customer because the customer makes all decisions regarding (1) which professional to hire and fire; (2) the professional’s salary, bonus, and benefits; (3) supervision and management; and (4) the day-to-day activities of the professional. Further, JW concludes that it is not primarily responsible for providing the professional’s services because JW is not responsible for the quality of the services provided and, if the professional quits, JW is not obligated to identify an alternative professional who can provide the services. JW also does not have discretion in determining the price because the customer sets the salary and bonus. Therefore, JW concludes that it should report revenue net of amounts paid to the professional.

A similar outcome would result if JW treated the amounts paid to the professional as “consideration payable to a customer” within the scope of the guidance in ASC 606-10-32-25 through 32-27 (see Section 6.6.2). Because the nature of JW’s promise is to arrange for the professional to provide services to the customer (and not to provide the professional’s services itself) and the customer is, in substance, employing the professional, any payments made to the professional are being made on behalf of the customer. Entity JW is not receiving a distinct good or service in connection with the payments. Consequently, any payments made to the professional would reduce the transaction price and, therefore, revenue.

10.2.2.2 Principal-Versus-Agent Considerations Related to Payment Processing Arrangements

For entities involved in payment processing arrangements, performing the principal-versus-agent analysis presents unique challenges. Specifically, entities have grappled with the issue of how to present revenue and the various fees related to payment processing in a manner consistent with the revenue standard. A careful evaluation of the relevant guidance is critical since the payments ecosystem — as well as the players — continues to evolve. Consideration must be given to the delivery model of the services, the parties involved in the payment transactions, and the various components in each fee arrangement. Whether an offering is integrated or independent can have a significant effect on the accounting analysis.

ASC 606-10-55-36 states, in part, that “[i]f a contract with a customer includes more than one specified good or service, an entity could be a principal for some specified goods or services and an agent for others.” Accordingly, for each specified good or service identified , an entity must determine whether it controls the specified good or service before transferring that good or service to the customer. Therefore, an entity in a payment processing arrangement must determine whether it has the ability to direct the use of, and obtain substantially all the benefits from, the services provided by other parties in the payment processing ecosystem before those services are transferred to the customer.

Determining which party controls the services provided by the other parties in the payment processing ecosystem requires significant judgment. Therefore, an entity may also evaluate the control indicators in ASC 606 to support its conclusion.

Factors to consider as part of this determination may include:

The nature of the entity’s contractual arrangements, relationships, and promises with the customer and other parties and the entity’s potential risks of loss (e.g., chargebacks, fees due to other parties) arising from the transaction. As part of this analysis, the entity may consider whether it acts as the “merchant of record” for the transactions that it processes.
Any contractual arrangements or relationships between the customer and the other parties in the payment processing ecosystem.
The ability of the entity to direct other parties in the payment processing ecosystem to provide payment processing services on its behalf. As part of this analysis, the entity may consider whether it establishes underwriting guidelines, has the ability to decline transactions or withhold funds, approves customer contracts, provides customer support, and has responsibility over the resolution of customer service issues.
Whether the customer views the entity to be primarily responsible for the payment processing services, including their acceptability.
The ability of the entity to enhance, modify, or discontinue payment processing services.
The ability of the entity to determine and subsequently change the parties that will be used to perform the various payment processing services.
The ability to set the overall price paid by the customer.
Whether the entity provides a significant service of integrating all of the services transferred to the customer.
The entity’s obligation to maintain payment processing information on behalf of the merchant, perform preauthorization services, and determine what payment processing information is provided to the other parties in the payment processing ecosystem.

10.2.3 Integrating a Good or Service From a Third Party With a Good or Service Controlled by the Entity

An entity would also be a principal when it integrates a good or service provided by a third party with other goods or services controlled by the entity. The entity’s performance obligation may be to transfer to the customer a distinct bundle of goods or services, a component of which is provided by the third party. The entity would need to obtain control of the third party’s good or service to integrate the good or service with the other goods or services promised to the customer. For example, a general contractor may enter into a contract with a customer to construct a house. The general contractor will most likely need to combine goods or services provided by third parties (e.g., subcontractors) to transfer the promised goods or services to its customer.

Example 10-5

Contractor A enters into a contract with Customer B to construct a house. Customer B requests that a specific brand of air-conditioning unit be included in the finished house. The contractor buys the air-conditioning unit from a third party (either the contractor is reimbursed by the customer or the contract price includes the price of the air-conditioning unit), completes the installation, and performs tests to ensure that the air-conditioning unit is working. That is, as part of its obligation to construct the house for the customer, A performs a significant service of integrating the air-conditioning unit into the house, which forms part of a single performance obligation. Contractor A therefore concludes that it controls the air-conditioning unit before the unit is transferred to the customer as part of the completed house.

Connecting the Dots

We believe that an entity should evaluate the level of integration between the various inputs in identifying its performance obligations when it uses third-party goods or services as inputs to produce or deliver a combined output. In addition, the entity should consider whether it has sufficient control over those inputs to significantly integrate them into its offering.

At the 2021 AICPA & CIMA Conference on Current SEC and PCAOB Developments, Mr. Wiggins discussed situations in which an entity may conclude that it is a principal because it takes a good or service from a third party and integrates that good or service into its own offering. In his discussion of entities’ contracts with customers involving a good or service from a third party, Mr. Wiggins highlighted the importance of determining (1) whether the entity is performing an integration service, (2) the nature of the integration service, (3) the significance of the integration service, and (4) whether the entity controls the third party’s good or service. He noted that if an entity does not control a promised good or service from a third party, it would be unclear how the entity can significantly integrate that promised good or service with its own offering.

10.2.4 Indicators That an Entity Is Acting as a Principal

In situations such as those described in Examples 10-3 and 10-5, an entity controls specified goods or services before they are transferred to the customer. This may be the case even if the entity does not fulfill the promise itself but directs a third party to fulfill the obligation on its behalf. In other situations, however, it may not be clear whether the entity does in fact obtain control of the goods or services provided by a third party before they are transferred to the customer, as illustrated in Example 10-1. In these circumstances, the entity will need to consider the indicators in ASC 606-10-55-39 and 55-39A when evaluating whether it is acting as a principal. Those indicators are listed and explained as follows:

ASC 606-10

55-39 Indicators that an entity controls the specified good or service before it is transferred to the customer (and is therefore a principal [see paragraph 606-10-55-37]) include, but are not limited to, the following:

The entity is primarily responsible for fulfilling the promise to provide the specified good or service. This typically includes responsibility for the acceptability of the specified good or service (for example, primary responsibility for the good or service meeting customer specifications). If the entity is primarily responsible for fulfilling the promise to provide the specified good or service, this may indicate that the other party involved in providing the specified good or service is acting on the entity’s behalf.
The entity has inventory risk before the specified good or service has been transferred to a customer or after transfer of control to the customer (for example, if the customer has a right of return). For example, if the entity obtains, or commits to obtain, the specified good or service before obtaining a contract with a customer, that may indicate that the entity has the ability to direct the use of, and obtain substantially all of the remaining benefits from, the good or service before it is transferred to the customer.
The entity has discretion in establishing the price for the specified good or service. Establishing the price that the customer pays for the specified good or service may indicate that the entity has the ability to direct the use of that good or service and obtain substantially all of the remaining benefits. However, an agent can have discretion in establishing prices in some cases. For example, an agent may have some flexibility in setting prices in order to generate additional revenue from its service of arranging for goods or services to be provided by other parties to customers.
Subparagraph superseded by Accounting Standards Update No. 2016-08.
Subparagraph superseded by Accounting Standards Update No. 2016-08.

55-39A The indicators in paragraph 606-10-55-39 may be more or less relevant to the assessment of control depending on the nature of the specified good or service and the terms and conditions of the contract. In addition, different indicators may provide more persuasive evidence in different contracts.

We have observed that primary responsibility and inventory risk tend to be important indicators in the overall principal-versus-agent analysis under the revenue standard. However, the relevance of particular control indicators may vary depending on the fact pattern. Consequently, an entity will need to determine whether it controls the underlying goods or services before they are transferred to the customer by considering how the control indicators should be evaluated under the facts and circumstances of the entity’s arrangements.

As discussed in ASU 2016-08, the FASB and IASB acknowledge that the indicators under the revenue standard are similar to indicators used under legacy U.S. GAAP. Specifically, paragraphs BC16 through BC18 state, in part:

BC16. The Boards’ considerations (explained in paragraph BC382 of Update 2014-09) highlight that the indicators in paragraph 606-10-55-39 were included to support an entity’s assessment of whether it controls a specified good or service before it is transferred to the customer. 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.

BC17. [T]he Boards decided to carry over some of the indicators in previous revenue recognition standards even though those indicators have a different purpose in the new standard. In the new standard, the indicators support the concepts of identifying performance obligations and the transfer of control of goods or services. Accordingly, the Boards had expected that the conclusions about principal versus agent under Topic 606 could be different in some scenarios from those reached under the previous revenue recognition standards. Furthermore, the Boards observed that although exposure to risks and rewards alone does not give an entity control, exposure to risks and rewards can be a helpful factor to consider in determining whether an entity has obtained control (see paragraph 606-10-25-30).

BC18. The Boards decided to amend the indicators in paragraph 606-10-55-39 to more clearly establish a link between the control principle and the indicators by:

Reframing the indicators as indicators of when an entity controls a specified good or service before transfer, rather than as indicators that an entity does not control the specified good or service before transfer.
Adding guidance to explain how each indicator supports the assessment of control as defined in paragraph 606-10-55-39. This should help entities apply indicators that are similar to those in the previous revenue recognition guidance but within the context of the control principle in Topic 606.
Removing the indicator relating to the form of the consideration. Although that indicator might sometimes be helpful in assessing whether an entity is an agent, the Boards concluded that it would not be helpful in assessing whether an entity is a principal.
Removing the indicator relating to exposure to credit risk. The feedback on the proposed Update highlighted that exposure to credit risk is generally not a helpful indicator when assessing whether an entity controls the specified good or service. Stakeholders observed that the credit risk indicator in the previous revenue guidance has been problematic from the perspective of entities trying to use exposure to credit risk to override stronger evidence of agency. The Boards concluded that removing the credit risk indicator should reduce some of the complexity in the principal versus agent evaluation because the credit risk indicator typically will be less (or not) relevant to the evaluation for contracts with customers within the scope of Topic 606.
Clarifying that the indicators are not an exhaustive list and merely support the assessment of control. They do not replace or override that assessment. The Boards decided to explicitly state that one or more of the indicators might provide more persuasive evidence to support the assessment of control in different scenarios.

As noted above, the indicators are intended to support the conclusion that the entity controls the specified goods or services before they are transferred to the customer. Typically, the principal that controls the specified goods or services will exhibit some or all of the control indicators. The indicators also help an entity evaluate whether it is exposed to significant risks and rewards associated with the contract with the customer. As also noted above, considering whether an entity has exposure to risks and rewards can be helpful (although this indicator alone would not confirm that the entity has control). Since the principal in a transaction is typically exposed to significant risks and rewards associated with the contract with a customer, the indicators help confirm whether an entity controls specified goods or services before they are transferred to a customer (and is therefore deemed to be the principal).

In a speech at the 2017 AICPA Conference on Current SEC and PCAOB Developments, Barry Kanczuker, associate chief accountant in the OCA, provided the following guidance on determining whether an entity is a principal or an agent:

I have observed that applying [the guidance in ASC 606 on determining whether an entity is a principal or an agent] can be challenging in some fact patterns. I believe that some of the challenges are amplified in certain industries, such as the digital advertising industry or other industries in the technology space, where there are often multiple parties involved in providing the good or service, and transactions often take place within the blink of an eye.

Last year at this conference, [then OCA Professional Accounting Fellow] Ruth Uejio made remarks that principal versus agent considerations in evolving business models may create “unique challenges that will require sound judgment.” I would like to continue this discussion. For example, I believe determining whether an entity controls a specified good or service immediately prior to the good or service being transferred to the customer may be especially challenging in certain types of service transactions, such as when enforceable contracts only exist among the parties once the service is being provided, or in transactions that take place in an instant. Topic 606 does provide indicators to support an entity’s assessment of whether it controls a specified good or service before it is transferred to the customer. However, these indicators of control should not be considered a checklist of criteria. The indicators may be more or less relevant to the assessment of control depending on the nature of the specified good or service and the terms and conditions of the contract. I believe that determining the relevance of an indicator to the assessment of control in certain types of transactions will require reasonable judgment.

As an example of the application of this guidance, I would like to share a recent pre-filing consultation that OCA received in the digital advertising space. In this consultation, the registrant’s customer, an advertiser, provided the registrant with specifications of the target audience it wished to reach through its digital advertising efforts. The advertiser’s specifications also included limited pricing information, such as the total advertising budget over a period of time. The registrant’s technology enabled it to identify and purchase advertising space that met the advertiser’s specifications on a real-time basis, as internet users in the advertiser’s target audience were browsing a website or viewing an app with available advertising space. The registrant had the ultimate discretion, including pricing discretion, for individual purchases of advertising space. The advertiser held the registrant responsible for reaching the advertiser’s target audience and otherwise meeting the advertiser’s specifications, and typically did not receive any information from the registrant that identified the specific websites or apps from which the registrant purchased the advertising space.

The registrant concluded that it was acting as a principal in the arrangement because it controlled the specified good or service before it was transferred to the customer. As part of its assessment of control, the registrant considered the indicators of control and noted that it was primarily responsible for fulfillment and had discretion in establishing the price. The staff views principal versus agent considerations to be an area that requires reasonable judgment — in this case, based on the facts and circumstances and the Topic 606 guidance, the staff did not object to the registrant’s conclusion that it was the principal in the transaction.

I want to be clear: an area of significant judgment does not mean that the standard permits optionality. In order to make these reasonable judgments, I believe that registrants need to “roll up their sleeves” to understand the nuances of the transactions and faithfully apply the Topic 606 model to their specific set of facts and circumstances. [Footnotes omitted]

As discussed in Mr. Kanczuker’s speech above, determining whether an entity is a principal or an agent can be challenging in certain industries, particularly the digital advertising industry. In a speech at the 2020 AICPA Conference on Current SEC and PCAOB Developments, Geoff Griffin, then professional accounting fellow in the OCA, discussed another similar fact pattern. In his speech, Mr. Griffin made the following observations related to the determination of whether an entity is a principal or an agent in a contract to provide a customer with access to the entity’s advertising platform:

Significant judgment is often required when determining whether an entity is a principal or an agent in a revenue transaction. As discussed in previous staff speeches, assessing whether an entity is a principal or agent under the applicable revenue guidance can be particularly challenging in certain industries, such as the digital advertising industry or other industries in the technology space, where arrangements often involve multiple parties providing the good or service. I would like to share a fact pattern that illustrates such an arrangement.

In this fact pattern, the registrant operated a platform that facilitated an advertiser’s purchase of advertising space from a publisher. The registrant identified a specific advertiser’s digital advertisement (“ad”) before bidding on potential advertising space in an auction process. Upon winning an auction, the registrant obtained an exclusive right to the potential advertising space and immediately pre-loaded the identified advertiser’s ad to the publisher’s site. If a valid user reaches the stage in the publisher’s app where the potential advertising space is to be displayed, the pre-loaded ad is displayed in the advertising space on the publisher’s site and a revenue transaction occurs.

The registrant concluded it was an agent in the transaction, despite the fact that it obtained momentary title to the advertising space, stating that it did not obtain control of the advertising space prior to transferring it to the customer. That is, the registrant concluded that it did not have the ability to direct the use of, and obtain substantially all the remaining benefits from, the publisher’s advertising space. Due to certain constraints, the registrant concluded it was unable to direct the use of the potential advertising space to an ad other than the predetermined ad in the seconds between winning the auction and the time the ad was displayed on the publisher’s site.

As part of its assessment, the registrant considered the indicators of control set forth in the revenue recognition guidance, determining that it was not primarily responsible for fulfillment and did not have inventory risk; however, the registrant determined that it did have pricing discretion as the publisher had no ability to set or influence the price charged to advertisers. In reaching its conclusion, the registrant stated that it was not primarily responsible for fulfillment based on the terms and conditions of its contract with the advertiser. The registrant believed that the terms and conditions of its contract only obligated it to provide an advertiser with access to the platform that facilitated the customer’s purchase of advertising space from publishers. Finally, the registrant stated that it did not promise its customer, explicitly or implicitly, the delivery of advertising space, nor did the customer have recourse against the registrant if its ad was not properly displayed in the advertising space or a valid user did not view the ad.

Based on the facts and circumstances presented to OCA staff, the staff did not object to the registrant’s conclusion that it was an agent in the transaction and should recognize revenue on a net basis. [Footnotes omitted]

Each of the indicators in ASC 606 that an entity is acting as a principal is further discussed below.

10.2.4.1 Primary Responsibility

The entity that has primary responsibility for fulfilling the obligation to the customer is often the entity that is most visible to the customer and the entity from which the customer believes it is acquiring goods or services. Often, the entity that has primary responsibility for fulfilling the promise to transfer goods or services to the customer will assume fulfillment risk (i.e., risk that the performance obligation will not be satisfied) and risks related to the acceptability of specified goods or services. That is, such an entity will typically address customer questions and complaints, rectify service issues, accept product returns, or be primarily responsible for exchanges or refunds. For example, when a customer purchases a flight on a Web site operated by a company that aggregates flight information and facilitates payment (e.g., a travel site), the airline rather than the travel site has the primary responsibility to provide the transportation service to the customer. If the flight were to be canceled or if baggage were to be lost, the customer would contact the airline to address the issue. Although the customer initially interacted with the travel site to arrange for the flight, the airline is primarily responsible for fulfilling the obligation to provide transportation services to the customer.

Similarly, in Example 10-1, when a customer purchases a good from an online retailer’s Web site that is shipped directly to the customer from the supplier, the customer would contact the retailer if there are quality issues or would return the good to the retailer if there is a defect. That is, even though the good was actually shipped directly from the supplier to the customer, the customer views the retailer as being primarily responsible for fulfilling the promise to transfer the specified good, and the retailer assumes significant risk related to fulfillment of that promise.

In some cases, it can be difficult to establish whether an entity has primary responsibility for fulfilling a promise to provide a specified good or service, and doing so may require significant judgment. For example, when two parties are involved in providing a specified good or service to a customer, both parties may have contact with the customer. Conversely, in other cases, it may be clear that an entity has primary responsibility. If it is clear that an entity has primary responsibility for fulfilling a promise to provide a specified good or service to a customer, we believe that this would typically mean that the entity is deemed to be the principal. Although ASC 606-10-55-39 lists primary responsibility as only an indicator, ASC 606-10-55-36 makes clear that when the principal-versus-agent analysis is performed, it is key to identify which party is promising to provide the specified good or service to the customer. If an entity has primary responsibility to the customer for providing a specified good or service, it will usually follow that the entity is the party that is promising to provide the good or service to the customer (i.e., the entity is a principal, not an agent), even if the entity has engaged another party (e.g., a subcontractor) to satisfy some or all of the performance obligation on its behalf.

10.2.4.2 Inventory Risk

When an entity has inventory risk, it is exposed to economic risk associated with either (1) holding the inventory before a customer is identified or (2) accepting product returns and being required to mitigate any resulting losses by reselling the product or negotiating returns with the supplier.

While holding the inventory, the entity bears the risk of loss as a result of obsolescence or destruction of inventory. This risk is generally referred to as front-end inventory risk. In the case of a service, the entity may commit to pay for a service before it identifies a customer for the service. This is also a form of inventory risk.

Another type of inventory risk is back-end inventory risk, which is economic risk assumed upon product return (when there is a general right of return). If an entity is willing to assume economic risk upon product return (and there is a general right of return), it is assuming some risk that is assumed by a principal in a transaction. However, in some instances, an entity may be willing to accept a return only if it can return the product to the supplier, in which case back-end inventory risk may be mitigated. When combined with other factors, the existence of back-end inventory risk may lead to a conclusion that the entity controls the specified good or service before it is transferred to the customer even if another party transfers the product or service directly to the customer. In Example 10-1, the online retailer does not have inventory risk before entering into a contract with a customer because the online retailer takes title to a good only momentarily before the supplier ships the good to a customer. However, if the customer were to be dissatisfied with the good, the customer would return it to the online retailer rather than the supplier. The online retailer would then have back-end inventory risk since it would have to determine whether it can resell the good to another customer or return the good to the supplier.

10.2.4.3 Discretion in Establishing Pricing

When an entity has control over the establishment of pricing, it generally assumes substantial risks and rewards related to the demand of the specified product or service, especially when the price it is required to pay a third party for the specified good or service is fixed. In contrast, when an entity acts as an agent in a transaction, the amount that the entity earns may be fixed (either in absolute dollars per transaction or as a fixed percentage of the sales price).

When combined with other factors, pricing discretion could indicate that the entity controls the specified good or service before it is transferred to the customer. However, ASC 606-10-55-39(c) states, in part, that “an agent can have discretion in establishing prices in some cases. For example, an agent may have some flexibility in setting prices in order to generate additional revenue from its service of arranging for goods or services to be provided by other parties to customers.”

Example 10-6

A food delivery service offers delivery of meals from restaurants to consumers within a certain radius from a specific location in a city. Via its Web site or app, the food delivery service connects a consumer with a restaurant and also delivers ordered food from the restaurant to the consumer. Each restaurant indicates its prices on the food delivery service’s platform and has the ability to change those prices daily. The food delivery service earns a 5 percent commission on sales from each restaurant order.

In this example, each restaurant has discretion in establishing pricing rather than the food delivery service. In addition, the restaurant is responsible for fulfilling the ordered food. This would suggest that the restaurant controls the specified good or service (i.e., the food ordered by the consumer) at all times before the food is transferred to the consumer.

Note, however, that the food delivery service may be the principal for the delivery service, particularly if it is primarily responsible for the delivery service, in which case it would be an agent for part of the transaction and a principal for another part. Refer to Section 10.4 for further discussion of contracts in which an entity is both a principal and an agent.

10.2.5 Codification Examples of Promised Goods or Services for Which an Entity Is a Principal (ASC 606-10-55-320 Through 55-329)

The following implementation guidance from the revenue standard will help an entity determine whether it is acting as a principal in a contract:

ASC 606-10

Example 46 — Promise to Provide Goods or Services (Entity Is a Principal)

55-320 An entity enters into a contract with a customer for equipment with unique specifications. The entity and the customer develop the specifications for the equipment, which the entity communicates to a supplier that the entity contracts with to manufacture the equipment. The entity also arranges to have the supplier deliver the equipment directly to the customer. Upon delivery of the equipment to the customer, the terms of the contract require the entity to pay the supplier the price agreed to by the entity and the supplier for manufacturing the equipment.

55-321 The entity and the customer negotiate the selling price, and the entity invoices the customer for the agreed-upon price with 30-day payment terms. The entity’s profit is based on the difference between the sales price negotiated with the customer and the price charged by the supplier.

55-322 The contract between the entity and the customer requires the customer to seek remedies for defects in the equipment from the supplier under the supplier’s warranty. However, the entity is responsible for any corrections to the equipment required resulting from errors in specifications.

55-323 To determine whether the entity’s performance obligation is to provide the specified goods or services itself (that is, the entity is a principal) or to arrange for those goods or services to be provided by another party (that is, the entity is an agent), the entity identifies the specified good or service to be provided to the customer and assesses whether it controls that good or service before the good or service is transferred to the customer.

Subparagraph superseded by Accounting Standards Update No. 2016-08.
Subparagraph superseded by Accounting Standards Update No. 2016-08.
Subparagraph superseded by Accounting Standards Update No. 2016-08.
Subparagraph superseded by Accounting Standards Update No. 2016-08.
Subparagraph superseded by Accounting Standards Update No. 2016-08.

55-323A The entity concludes that it has promised to provide the customer with specialized equipment designed by the entity. Although the entity has subcontracted the manufacturing of the equipment to the supplier, the entity concludes that the design and manufacturing of the equipment are not distinct because they are not separately identifiable (that is, there is a single performance obligation). The entity is responsible for the overall management of the contract (for example, by ensuring that the manufacturing service conforms to the specifications) and thus provides a significant service of integrating those items into the combined output — the specialized equipment — for which the customer has contracted. In addition, those activities are highly interrelated. If necessary modifications to the specifications are identified as the equipment is manufactured, the entity is responsible for developing and communicating revisions to the supplier and for ensuring that any associated rework required conforms with the revised specifications. Accordingly, the entity identifies the specified good to be provided to the customer as the specialized equipment.

55-323B The entity concludes that it controls the specialized equipment before that equipment is transferred to the customer (see paragraph 606-10-55-37A(c)). The entity provides the significant integration service necessary to produce the specialized equipment and, therefore, controls the specialized equipment before it is transferred to the customer. The entity directs the use of the supplier’s manufacturing service as an input in creating the combined output that is the specialized equipment. In reaching the conclusion that it controls the specialized equipment before that equipment is transferred to the customer, the entity also observes that even though the supplier delivers the specialized equipment to the customer, the supplier has no ability to direct its use (that is, the terms of the contract between the entity and the supplier preclude the supplier from using the specialized equipment for another purpose or directing that equipment to another customer). The entity also obtains the remaining benefits from the specialized equipment by being entitled to the consideration in the contract from the customer.

55-324 Thus, the entity concludes that it is a principal in the transaction. The entity does not consider the indicators in paragraph 606-10-55-39 because the evaluation above is conclusive without consideration of the indicators. The entity recognizes revenue in the gross amount of consideration to which it is entitled from the customer in exchange for the specialized equipment.

Example 46A — Promise to Provide Goods or Services (Entity Is a Principal)

55-324A An entity enters into a contract with a customer to provide office maintenance services. The entity and the customer define and agree on the scope of the services and negotiate the price. The entity is responsible for ensuring that the services are performed in accordance with the terms and conditions in the contract. The entity invoices the customer for the agreed-upon price on a monthly basis with 10-day payment terms.

55-324B The entity regularly engages third-party service providers to provide office maintenance services to its customers. When the entity obtains a contract from a customer, the entity enters into a contract with one of those service providers, directing the service provider to perform office maintenance services for the customer. The payment terms in the contracts with the service providers generally are aligned with the payment terms in the entity’s contracts with customers. However, the entity is obliged to pay the service provider even if the customer fails to pay.

55-324C To determine whether the entity is a principal or an agent, the entity identifies the specified good or service to be provided to the customer and assesses whether it controls that good or service before the good or service is transferred to the customer.

55-324D The entity observes that the specified services to be provided to the customer are the office maintenance services for which the customer contracted and that no other goods or services are promised to the customer. While the entity obtains a right to office maintenance services from the service provider after entering into the contract with the customer, that right is not transferred to the customer. That is, the entity retains the ability to direct the use of, and obtain substantially all the remaining benefits from, that right. For example, the entity can decide whether to direct the service provider to provide the office maintenance services for that customer, or for another customer, or at its own facilities. The customer does not have a right to direct the service provider to perform services that the entity has not agreed to provide. Therefore, the right to office maintenance services obtained by the entity from the service provider is not the specified good or service in its contract with the customer.

55-324E The entity concludes that it controls the specified services before they are provided to the customer. The entity obtains control of a right to office maintenance services after entering into the contract with the customer but before those services are provided to the customer. The terms of the entity’s contract with the service provider give the entity the ability to direct the service provider to provide the specified services on the entity’s behalf (see paragraph 606-10-55-37A(b)). In addition, the entity concludes that the following indicators in paragraph 606-10-55-39 provide further evidence that the entity controls the office maintenance services before they are provided to the customer:

The entity is primarily responsible for fulfilling the promise to provide office maintenance services. Although the entity has hired a service provider to perform the services promised to the customer, it is the entity itself that is responsible for ensuring that the services are performed and are acceptable to the customer (that is, the entity is responsible for fulfilment of the promise in the contract, regardless of whether the entity performs the services itself or engages a third-party service provider to perform the services).
The entity has discretion in setting the price for the services to the customer.

55-324F The entity observes that it does not commit itself to obtain the services from the service provider before obtaining the contract with the customer. Thus, the entity has mitigated its inventory risk with respect to the office maintenance services. Nonetheless, the entity concludes that it controls the office maintenance services before they are provided to the customer on the basis of the evidence in paragraph 606-10-55-324E.

55-324G Thus, the entity is a principal in the transaction and recognizes revenue in the amount of consideration to which it is entitled from the customer in exchange for the office maintenance services.

Example 47 — Promise to Provide Goods or Services (Entity Is a Principal)

55-325 An entity negotiates with major airlines to purchase tickets at reduced rates compared with the price of tickets sold directly by the airlines to the public. The entity agrees to buy a specific number of tickets and must pay for those tickets regardless of whether it is able to resell them. The reduced rate paid by the entity for each ticket purchased is negotiated and agreed in advance.

55-326 The entity determines the prices at which the airline tickets will be sold to its customers. The entity sells the tickets and collects the consideration from customers when the tickets are purchased.

55-327 The entity also assists the customers in resolving complaints with the service provided by the airlines. However, each airline is responsible for fulfilling obligations associated with the ticket, including remedies to a customer for dissatisfaction with the service.

55-328 To determine whether the entity’s performance obligation is to provide the specified goods or services itself (that is, the entity is a principal) or to arrange for those goods or services to be provided by another party (that is, the entity is an agent), the entity identifies the specified good or service to be provided to the customer and assesses whether it controls that good or service before the good or service is transferred to the customer.

Subparagraph superseded by Accounting Standards Update No. 2016-08.
Subparagraph superseded by Accounting Standards Update No. 2016-08.
Subparagraph superseded by Accounting Standards Update No. 2016-08.
Subparagraph superseded by Accounting Standards Update No. 2016-08.

55-328A The entity concludes that with each ticket that it commits itself to purchase from the airline, it obtains control of a right to fly on a specified flight (in the form of a ticket) that the entity then transfers to one of its customers (see paragraph 606-10-55-37A(a)). Consequently, the entity determines that the specified good or service to be provided to its customer is that right (to a seat on a specific flight) that the entity controls. The entity observes that no other goods or services are promised to the customer.

55-328B The entity controls the right to each flight before it transfers that specified right to one of its customers because the entity has the ability to direct the use of that right by deciding whether to use the ticket to fulfill a contract with a customer and, if so, which contract it will fulfill. The entity also has the ability to obtain the remaining benefits from that right by either reselling the ticket and obtaining all of the proceeds from the sale or, alternatively, using the ticket itself.

55-328C The indicators in paragraph 606-10-55-39(b) through (c) also provide relevant evidence that the entity controls each specified right (ticket) before it is transferred to the customer. The entity has inventory risk with respect to the ticket because the entity committed itself to obtain the ticket from the airline before obtaining a contract with a customer to purchase the ticket. This is because the entity is obliged to pay the airline for that right regardless of whether it is able to obtain a customer to resell the ticket to or whether it can obtain a favorable price for the ticket. The entity also establishes the price that the customer will pay for the specified ticket.

55-329 Thus, the entity concludes that it is a principal in the transactions with customers. The entity recognizes revenue in the gross amount of consideration to which it is entitled in exchange for the tickets transferred to the customers.

Footnotes

Similarly, a professional employer organization (PEO) may provide services under a co-employment model in which it does not control the employees but serves as the EOR for payroll purposes. In this circumstance, the nature of the PEO’s promise may be solely to provide payroll services.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.