10.4 Contracts in Which the Entity Is a Principal and an Agent

Company X, 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 and app, the food delivery service connects a consumer with a restaurant, processes food orders, and provides a service of delivering food to the consumer. Each restaurant has full discretion to establish the price for its food ordered through X. The food delivery service earns a 5 percent commission on sales from each restaurant order and charges a flat delivery fee of $10 per order. The restaurant is responsible for fulfilling the ordered food and addressing all consumer complaints regarding the quality of the food or an incorrect order. If the food is compromised while in transit, X is liable.

Company X is responsible for delivering the food and can change the delivery fee at its discretion. Company X takes custody of the food ordered from a restaurant, but it can deliver the food only to the consumer’s location. Company X uses independent contractors (ICs) to perform the delivery service, and such ICs commit to being available to provide the delivery service at set schedules. When an IC is presented with a delivery request, that IC can decide whether to accept or reject the request. If an IC accepts a request, X will direct the IC to pick up the food at a specific restaurant and deliver the good to a specific consumer. If, instead, an IC rejects a request, X is still obligated to provide the delivery service and will attempt to find another IC to perform the delivery. In some cases, X will take a loss on the delivery service by paying an IC a rate higher than the delivery fee to fulfill the delivery.

Assume that the food and the delivery service are each capable of being distinct and distinct within the context of the contract (see Chapter 5).

In this example, X does not obtain control of the food (one of the specified goods or services) before it is transferred to the consumer. Although X takes custody of the food, it cannot redirect the food to another consumer or consume the good (the food) as a resource. Further, X is not responsible for fulfilling the food order or addressing consumer complaints, does not purchase the food before the food is transferred to the consumer, and does not have discretion to establish the price of the food. Company X is acting as an agent and arranging for the restaurant to fulfill the promise to transfer food to the consumer.

However, X is primarily responsible for providing the service of delivering the food to the consumer. If the food is compromised while in transit, X is liable to the customer. Although ICs are used to perform the delivery service and an individual IC can reject a particular delivery, X is still obligated to provide the delivery service and is required to identify another IC to complete the delivery service even if doing so results in a loss to X. Further, X has full discretion to establish the price of the delivery service. Consequently, X is the principal for the delivery service.

Company A is a reseller of a wide range of technology solutions, including SaaS platforms. The marketing materials of A primarily emphasize its ability to add value to the purchasing process of end customers by helping them select and procure the most appropriate technology solution.

Company A enters into reseller agreements with vendors. Each of these agreements allows A to (1) resell a vendor’s on-premise software licenses and (2) resell that vendor’s SaaS platform as a subscription-based service. Company A has the ability to choose from which vendor it will purchase the products needed to fulfill the end customers’ orders.

A customer purchases an on-premise software license by executing a purchase order with A. Company A then purchases the license from a vendor by executing a purchase order with that vendor. Company A’s contract with the vendor allows A to sell the vendor’s license to any customer that A identifies (i.e., the vendor cannot reject a customer order except for protective reasons, and scenarios in which rejection of a customer order is permissible are expected to be remote). Company A is responsible for collecting payment from the customer, and A’s obligation to pay the vendor is not contingent on successfully collecting payment from the customer. Company A has full discretion in setting the price for the license that it resells. All sales of each vendor’s software license are subject to the vendor’s end user license agreement (EULA).

A vendor delivers a license directly to an end customer via an electronic key on the basis of information specified in the purchase order between A and the vendor. Company A is responsible for (1) assisting the customer if the customer encounters issues downloading and installing the software (all software is provided electronically) and (2) processing returns if the license does not conform to the specifications identified in the customer’s purchase order.

Company A also enters into contracts with end customers to allow them to access and use a SaaS platform hosted by a vendor for a defined period. For each sale, A earns a commission of 20 percent of the total sales price. All sales of each vendor’s SaaS platform are subject to the vendor’s EULA. The EULA does not contain substantive terms that define each party’s rights and obligations arising from the purchase. Each of A’s contracts with an end customer specifies that A does not warrant the performance or integrity of the service and does not make any warranties or guarantees regarding the service. If A’s reseller agreement with a vendor is terminated, the vendor will continue to provide services to all existing end customer subscriptions under the same terms and conditions until the expiration or cancellation of the respective subscription periods.

In 20X1, an end customer enters into a purchase order with A to purchase access to Vendor B’s SaaS platform for a one-year subscription period and B’s on-premise software license for a three-year term. The end customer pays A an up-front fee of $2 million for access to the SaaS platform and $4 million for the on-premise software license. Company A remits $1.6 million to B and retains $400,000 as its commission for the SaaS platform subscription sale. In addition, A remits $3.2 million to B for the on-premise software license in accordance with the purchase order executed between A and B. Company A then facilitates initial access to B’s SaaS platform through an electronic online portal hosted by B. Although the online portal is hosted by B, A is responsible for ensuring that the end customer gains access to the SaaS through the portal. Company A also directs B to provide the end customer with an activation key to enable the end customer to download the on-premise software license.

Company A identifies B’s on-premise software license and SaaS platform subscription as specified distinct goods and services and thus evaluates whether it obtains control of each of those specified goods and services before they are transferred to the end customer.

Although A has a contract with B to resell B’s SaaS, A does not obtain a right from B that allows it to control B’s SaaS platform before the service is delivered to an end customer. Company A evaluates the definition of control under ASC 606-10-25-25 and notes that it can neither direct the use of B’s SaaS platform nor prevent B from directing such use. Although A can instruct B to deliver initial access to the end customer, the end customer cannot benefit from initial access unless B continues to provide the SaaS for the duration of the one-year subscription. Therefore, delivery of the specified service is contingent on B’s ongoing actions, which A cannot direct (e.g., A cannot prevent B from ceasing to provide the customer with the service). Although A is regarded as the party that invoices the end customer for B’s SaaS platform, this factor alone does not determine whether A is acting as the principal or the agent in the transaction. In this situation, the end customer enters into a contractual relationship with B by agreeing to its EULA.

In addition, A considers the control indicators outlined in ASC 606-10-55-39, which it believes supports its control assessment under ASC 606-10-25-25. Company A is responsible for arranging access to B’s service (indicating that A bears initial fulfillment risk) and confirming that the end customer can successfully access the service (indicating that A has initial acceptability risk). However, A concludes that these initial fulfillment and acceptability risks are less relevant to determining whether it controls B’s SaaS platform. This is because the end customer cannot fully benefit from B’s SaaS platform simply by being granted initial access. The end customer can only gain the benefits of the service if B continuously provides it throughout the one-year subscription (i.e., interaction with B’s SaaS platform must be ongoing for the end customer to use the service). Further, B is responsible for any service-related issues tied to its SaaS offering, such as reliability and downtime. Thus, even though the end customer initially interacts with A to obtain access to B’s service, the end customer understands that B primarily fulfills this obligation.

Lastly, A notes that it does not have substantive inventory risk. Although A has the sole discretion to establish pricing for the end customer (an indicator that A may be acting as a principal), this factor alone is not definitive in the analysis.

On the basis of the above assessment, A concludes that it is acting as an agent that is responsible for arranging for B to provide B’s SaaS platform subscription service to the end customer.

Conversely, A concludes that it controls B’s software license in accordance with ASC 606-10-25-25 before the software license is provided to the end customer. This is because A has the ability to direct B to provide the software license to the end customer on A’s behalf and there are no additional or ongoing goods or services required for the customer to obtain the full benefit of the software license after initial access and right of use have been transferred. In addition, A is able to obtain substantially all of the remaining benefits from the software license before transferring it to the customer because A sells the software license at a selling price that A has full discretion to determine. Company A also considers that although the vendor enters into a EULA with the end customer, the EULA is not a sales agreement. Rather, the EULA defines the terms and conditions under which the end customer is allowed to use the software.

Company A further considers the control indicators outlined in ASC 606-10-55-39 and notes that although B delivers the software license directly to the end customer and the end customer most likely understands that B, rather than A, is the entity that developed the software, the end customer will seek resolution from A rather than B if there is a problem with the initial delivery of the software license to the end customer (e.g., if the end customer does not receive an access code or installation instructions from B, is unable to download the software, or determines that the software license received is not as specified). In addition, the purchase order for the software license is only between A and the end customer; B does not have a separate agreement with the customer that defines each party’s rights and obligations. Therefore, A concludes that it is primarily responsible for fulfilling the promise to provide such specified good (i.e., the software license) to the end customer.

Because A neither purchased the software license from B before executing a purchase order with the end customer nor had any minimum purchase commitments with B, A determines that there is no inventory risk associated with the software license. Further, A notes that it has discretion to establish the price of the software license, which is not subject to B’s review or approval in any way.

On the basis of the above, A concludes that it obtains control of B’s software license before the software license is transferred to the end customer and that it is therefore the principal for the promise to provide B’s software license to the end customer.

In this example, since A is acting as an agent for arranging for B to provide B’s SaaS platform subscription to the end customers and is acting as a principal for the provision of B’s software license to the end customer in the same contract, A would allocate the transaction price to all of the performance obligations (i.e., the performance obligation for which A is acting as a principal as well as the performance obligation for which A is acting as an agent) on a relative stand-alone selling price basis. See Section 10.4.2 for considerations related to allocating the transaction price when an entity is a principal for some performance obligations and an agent for other performance obligations.

Entity X sells two distinct products, Item 1 and Item 2, and provides a distinct service to Customer Z for a total contract price of $180,000. The products and the service are all transferred to the customer at different times. The stand-alone selling prices are as follows:

Entity X determines that it is the principal for the sale of Item 1 and Item 2 but that it is an agent for the service. Entity X agrees to sell the service for $60,000 on behalf of a third-party service provider for a 25 percent commission and bundles the service with its products. Thus, $45,000 is remitted to the third-party service provider, and X retains a $15,000 commission. Assume that the criteria for allocating a discount to one or more, but not all, performance obligations in accordance with ASC 606-10-32-37 are not met.

Entity X determines that the stand-alone selling price of the service provided as an agent is $15,000 (and that therefore, the total stand-alone price of the performance obligations is $165,000). Because X must remit $45,000 back to the third-party service provider and retains only a $15,000 commission, X determines that the total consideration it is entitled to receive is $135,000 rather than the contract price of $180,000. Therefore, X allocates the $135,000 transaction price to Item 1, Item 2, and the service on a relative stand-alone selling price basis, as shown in the table below.

The facts and circumstances in this example may suggest that X’s performance obligations are provided to two separate customers (i.e., the facts and circumstances may support a determination that those performance obligations for which X acts as a principal (Item 1 and Item 2) are transferred to the end customer, and the performance obligation for which X acts as an agent (arranging for the service to be provided by the third party) is performed on behalf of the third party). If so, we believe that it is acceptable for X to (1) allocate $120,000 ($180,000 contract price – $60,000 stand-alone selling price of the service) to Item 1 and Item 2 on a relative stand-alone selling price basis and (2) allocate the $15,000 commission received from the third-party service provider directly to the service. The allocations are shown in the table below.