FRS 115 includes application guidance for an entity to determine whether it is a principal or an agent i.e. based on whether it controls the specified goods or services before the transaction (principal) or not (agent).
Key Learning Point
When a third party is involved in providing goods or services to a customer, the entity needs to evaluate whether its performance obligation is to provide the good or service itself (ass a principal) or to arrange for another party to provide the good or service (as an agent).
An entity is a principal if it controls the promised good or service before transferring control to the customer.
An entity is an agent if it does not control the promised good or service and arranges for another entity to provide those goods or services.
In making assessment as to whether an entity obtains control of a good and service before providing it to the end-customer, the entity must consider the definition of control. Control is the ability of the entity to:
- direct the use of the asset
- obtain substantially all of the remaining benefits from the use of the asset
- prevent others from directing the use of, and receiving the benefit from the asset.
The evaluation whether an entity is acting as a principal or as an agent is made in relation to each specified good and service separately.
Recognition of revenues
In identifying if the entity is an agent in a contract, the following non-exhaustive list of indicators that a performance obligation involves an agency relationship:
- Another party has primary responsibility for fulfilling the contract
- The entity has no inventory risk before or after the goods is transferred to the customer, during shipping or on return
- The entity does not have discretion to establish pricing for the other party’s goods or services (i.e., the benefit the entity can receive from those goods or services is limited)
- The entity’s consideration is in the form of a commission
- The entity is not exposed to credit risk for the amount receivable in exchange for the goods or services.
The entity will be recognised revenue when (or as) it satisfies the performance obligations:
- As a principal, recognised revenue when (or as) it transfers the goods to the customer, and it records revenue on a gross basis.
- As an agent, recognised revenue when its performance obligation to arrange for goods is complete, and it records as revenue the net amount it retains as a commission.
Impact: Companies will need have proper identification of performance obligation and assess whether they act as principals or agents.
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