10.5 Other Considerations
10.5.1 Change in the Nature of the Customer and Vendor Relationship
Sometimes, an entity may contractually and legally transfer its
obligations to satisfy some or all of its promises under a contract with a
customer. This situation is discussed in ASC 606-10-55-40.
ASC
606-10
55-40 If another entity assumes
the entity’s performance obligations and contractual
rights in the contract so that the entity is no longer
obliged to satisfy the performance obligation to
transfer the specified good or service to the customer
(that is, the entity is no longer acting as the
principal), the entity should not recognize revenue for
that performance obligation. Instead, the entity should
evaluate whether to recognize revenue for satisfying a
performance obligation to obtain a contract for the
other party (that is, whether the entity is acting as an
agent).
An entity that was initially the principal in a transaction
should perform a careful analysis of its performance obligation before
concluding that it is no longer primarily responsible for fulfilling its promise
under the contract. A customer would most likely need to agree to ceding the
contract to another party and would look to that third party as the entity that
is primarily responsible for the fulfillment of the contract.
10.5.2 Presentation of Sales Taxes and Similar Taxes Collected From Customers
Under step 3 of the revenue standard (see Chapter 6), the
transaction price is the “amount of consideration to which an entity expects to
be entitled in exchange for transferring promised goods or services to a
customer, excluding amounts collected on behalf of third parties.” Stakeholders
have questioned whether sales taxes and similar taxes (“sales taxes”) should be
excluded from the transaction price when such taxes are collected on behalf of
tax authorities.
Further, the revenue standard’s guidance on assessing whether an
entity is a principal or an agent in a transaction is relevant to the assessment
of whether sales taxes should be presented gross or net within revenue. The
analysis is further complicated by the sales tax regulations in each tax
jurisdiction (which would include all taxation levels in both domestic and
foreign governmental jurisdictions), especially for entities that operate in a
significant number of jurisdictions.
ASC
606-10
32-2A An entity may make an
accounting policy election to exclude from the
measurement of the transaction price all taxes assessed
by a governmental authority that are both imposed on and
concurrent with a specific revenue-producing transaction
and collected by the entity from a customer (for
example, sales, use, value added, and some excise
taxes). Taxes assessed on an entity’s total gross
receipts or imposed during the inventory procurement
process shall be excluded from the scope of the
election. An entity that makes this election shall
exclude from the transaction price all taxes in the
scope of the election and shall comply with the
applicable accounting policy guidance, including the
disclosure requirements in paragraphs 235-10-50-1
through 50-6.
The FASB decided to provide in ASU 2016-122 a practical expedient (codified in ASC 606-10-32-2A) that permits entities
to exclude from the transaction price all sales taxes that are assessed by a
governmental authority and that are “imposed on and concurrent with a specific
revenue-producing transaction and collected by the entity from a customer (for
example, sales, use, value added, and some excise taxes).” However, such an
accounting policy election does not apply to taxes assessed on “an entity’s
total gross receipts or imposed during the inventory procurement process.” An
entity that elects to exclude sales taxes is required to provide the accounting
policy disclosures in ASC 235-10-50-1 through 50-6. See Chapter 15 on
disclosure.
Further, an entity that does not elect to present all sales
taxes on a net basis would be required to assess, for every tax jurisdiction,
whether it is a principal or an agent in the sales tax transaction and would
present sales taxes on a gross basis if it is a principal in the jurisdiction
and on a net basis if it is an agent. For more information on making this
assessment, see Section
6.7.
10.5.3 Income Tax Withholdings
The example below illustrates how an entity that acts as a
principal to provide services to a customer would account for income tax that
the customer withholds and remits to the customer’s local government on behalf
of the entity providing the services.
Example 10-11
Company X performs consulting services
for Company C, which is located in a country other than
that of X. Company C owes a $100 fee to X for performing
the consulting services and withholds 20 percent of the
fee as a local income tax withholding. Company C
transmits this amount to its local government on behalf
of X (X retains the primary responsibility to pay the
tax in C’s tax jurisdiction). Company C pays the
remaining 80 percent balance to X. The countries do not
have a tax treaty, and X is not required to file a tax
return in C’s country. Company X was fully aware that
the 20 percent income tax would be withheld in C’s
country when it agreed to perform the consulting
services for C.
Company X is the principal in providing
the consulting services to C (i.e., there are no third
parties involved in providing the services). Company X
also has the primary responsibility to pay the tax in
C’s tax jurisdiction, and C is simply paying the tax on
X’s behalf (acting as a collection agent). Consequently,
X should recognize revenue in the gross amount of
consideration to which it expects to be entitled in
exchange for those services and should therefore report
revenue of $100 and income tax expense of $20 (i.e., X
should not report net revenue of $80).
Company X is not eligible for the
practical expedient in ASC 606-10-32-2A in this instance
because the amount being withheld is income tax, not
sales tax. See Section 10.5.2 for
further discussion of the sales tax practical expedient
in ASC 606-10-32-2A.
10.5.4 Presentation of Shipping and Handling Costs Billed to Customers
Many vendors charge customers for shipping and handling of
goods. Shipping costs include costs incurred to move the product from the
seller’s place of business to the buyer’s designated location and include
payments to third-party shippers. Shipping costs may also be costs incurred
directly by the seller (e.g., salaries and overhead related to the activities
needed to prepare the goods for shipment). Handling costs include costs incurred
to store, move, and prepare the products for shipment. Generally, handling costs
are incurred from when the product is removed from finished-goods inventory to
when the product is provided to the shipper and may include an allocation of
internal overhead.
Some vendors charge customers a separate fee for shipping and
handling costs. Alternatively, shipping and handling might be included in the
price of the product. In some cases, the separate fee may be a standard amount
that does not necessarily correlate directly with the costs incurred for the
specific shipment. In other cases, the separate fee may be a direct
reimbursement for shipping and any direct incremental handling costs incurred or
may include a margin on top of those costs.
ASU
2016-10 provides a practical expedient that permits shipping
and handling costs that occur after control of the promised goods or services is
transferred to the customer to be presented as fulfillment costs. That is,
shipping and handling does not need to be identified as a promised good or
service and a potential performance obligation. ASC 606-10-25-18B (added by ASU
2016-10) states:
If shipping and handling activities are performed after a customer
obtains control of the good, then the entity may elect to account for
shipping and handling as activities to fulfill the promise to transfer
the good. The entity shall apply this accounting policy election
consistently to similar types of transactions. An entity that makes this
election would not evaluate whether shipping and handling activities are
promised services to its customers. If revenue is recognized for the
related good before the shipping and handling activities occur, the
related costs of those shipping and handling activities shall be
accrued. An entity that applies this accounting policy election shall
comply with the accounting policy disclosure requirements in paragraphs
235-10-50-1 through 50-6.
If an entity does not avail itself of the aforementioned
practical expedient, the appropriate presentation of amounts billed to a
customer for shipping and handling will depend on an analysis of the
principal-versus-agent considerations in ASC 606 related to shipping and
handling services. If control of the goods is transferred on receipt by the
customer (e.g., on “free on board” destination), the vendor will generally be
considered to be the principal with respect to the shipping and handling
services. If, however, control of the goods is transferred when the goods are
shipped, the vendor will need to determine whether it is the principal or the
agent with respect to the shipping service.
If, after consideration of the requirements in ASC 606-10-55-36
through 55-40, the vendor determines that it is responsible for shipping and
handling as a principal, all amounts billed to a customer in a sale transaction
related to shipping and handling represent revenues earned for the goods
provided (and the shipping services rendered, if the shipping service represents
a distinct performance obligation) and will be presented as revenue.
However, if the vendor considers the requirements of ASC
606-10-55-36 through 55-40 and determines that it is not responsible to the
customer for shipping but is instead acting merely as the buyer’s agent in
arranging for a third party to provide shipping services to the buyer, the
vendor should not report the amount charged by that third party for shipping as
its own revenue. Instead, the vendor should report as revenue only the
commission it has received (if any) for arranging shipping, which is the excess
of (1) any amounts the vendor charged the customer for shipping services over
(2) any amounts paid to the third party for those services.
10.5.5 Revenue Equal to Costs
An entity may determine, in accordance with ASC 606-10-55-36
through 55-40, that it provides goods, services, or both as a principal. In
addition, the entity may sell some goods and services to third parties at an
amount equal to the cost of the goods and services.
In these circumstances, the entity is not permitted to
present the associated revenues and expenses on a net basis. When an entity has
determined that it acts as a principal in the sale of goods, services, or both,
it should recognize revenue in the gross amount to which it is entitled. The
practice of selling goods or providing services at an amount equal to cost does
not mean that the revenue should be presented as a cost reimbursement. Revenue
and expenses should, therefore, be presented gross.
For additional information, see Section 10.5.7.
10.5.6 Royalty Considerations
The example below considers whether an entity that acts as a
principal should (1) offset the royalties it pays a third party to fulfill a
contract with a customer against revenue received from the customer or (2)
recognize the royalty payments as a cost of fulfilling the contract with the
customer.
Example 10-12
Entity A has agreed to pay a royalty to
Entity B for the use of the intellectual property rights
that A requires to make sales to its customers. The
royalty is specified as a percentage of gross proceeds
from A’s sales to its customers less certain
contractually defined costs. Entity A is the principal
in sales transactions with its customers (i.e., it must
provide the goods and services itself and does not act
as an agent for B).
Because A is the principal in sales
transactions with its customers, it should recognize its
revenue on a gross basis and the royalty as a cost of
fulfilling the contract.
For guidance on accounting for the costs of fulfilling a
contract, including whether such costs should be capitalized or expensed, see
ASC 340-40, as discussed in Chapter 13.
10.5.7 Shared Commissions
The example below considers whether an entity may offset
expenses against revenue from shared commissions.
Example 10-13
Company A has signed a contract with an insurance company
under which it receives a commission for every policy it
sells on behalf of the insurance company. Company A
contracts with individual financial advisers to sell
these insurance policies and agrees to split the
commission evenly with the financial advisers. Company A
provides administrative facilities and office space to
the financial advisers. The insurance company is aware
of the arrangements between A and the financial
advisers, but its contractual relationship is with A,
and A is responsible for providing the service to the
insurance company. The insurance company pays the full
commission to A, which then pays half of the commission
to the financial adviser that sold the policy.
Company A has determined that it is
acting as a principal in this arrangement in accordance
with ASC 606-10-55-36 through 55-40.
Company A is not permitted to offset the amount it
pays to the financial advisers against the commission
revenue it receives from the insurance company. Because
A is acting as a principal in providing services to the
insurance company and not as an agent for the financial
advisers, it is required to present the revenue it
receives for those services as a gross amount.
10.5.8 Estimating Gross Revenue as a Principal
In deliberating ASU 2016-08 and Clarifications to IFRS
15, the FASB and IASB were informed of facts and circumstances under which
an entity is determined to be a principal in a contract with a customer when
there is uncertainty in the transaction price that is unlikely to be resolved.
Such uncertainty may arise because the entity does not have, and will not
obtain, sufficient transparency into the intermediary’s pricing.
As noted in paragraph BC38 of ASU 2016-08, the FASB
contemplated, but ultimately rejected, amendments to ASC 606 to address these
types of transactions. Rather, the Board found the guidance in step 3 of the
revenue model to be helpful in the determination of what amounts are variable
consideration and thus should be included in the transaction price.
Specifically, paragraph BC38(c) states, in part:
A key tenet
of variable consideration is that at some point the uncertainty in the
transaction price ultimately will be resolved. When the uncertainty is not
expected to ultimately be resolved, the guidance indicates that the
difference between the amount to which the entity is entitled from the
intermediary and the amount charged by the intermediary to the end customer
is not variable consideration and, therefore, is not part of the entity’s
transaction price.
Accordingly, for the transactions contemplated above, the Board found it
reasonable for the principal to include in its transaction price the amounts
known (i.e., the amounts to which the entity expects to be entitled from the
intermediary).
Footnotes
2
The IASB did not amend IFRS 15 for this practical
expedient. For a summary of differences between U.S. GAAP and IFRS
Accounting Standards, see Appendix A.