Introduction
When another party is involved in providing goods or services to a customer, IFRS 15 requires an entity to determine whether it is a principal or an agent. A principal promises to provide the specified good or service itself. An agent promises to arrange for another party to provide it.
The test is control. An entity is a principal if it controls the specified good or service before it is transferred to the customer. The guidance sits in paragraphs B34 to B38 of the standard.
| Principal | Agent | |
|---|---|---|
| Promise to the customer | Provide the good or service | Arrange for another party to provide it |
| Controls the good or service before transfer | Yes | No |
| Revenue recognised | Gross amount of consideration | Net fee or commission |
| Amount paid to the other party | Cost of sales | Deducted from revenue; a payable until settled |
Profit is the same either way. Revenue, cost of sales and gross margin are not, which is why the conclusion matters to marketplaces, resellers, travel businesses and any entity whose performance is judged on revenue. The assessment forms part of step 2 of the five-step model, set out in our complete guide to IFRS 15.
Identifying the Specified Good or Service
The assessment starts by identifying what, precisely, is being provided to the customer. A specified good or service is a distinct good or service, or a distinct bundle, to be provided to the customer. It may be:
- a physical good or other asset, such as a product sold through a platform;
- a service performed by another party, such as a flight or a hotel stay; or
- a right to a good or service to be provided in future, such as an airline ticket or a restaurant voucher.
Getting this step right usually settles the rest. A travel business that pre-purchases hotel rooms is providing the room night. A booking website that lists hotels is providing access to the booking, with the hotel providing the room. Framing the specified service too broadly, for example as "a holiday", can obscure which party controls each component.
Where a contract contains more than one specified good or service, each is assessed separately. An entity can be a principal for some and an agent for others within the same contract.
The Control Test
Control is the ability to direct the use of, and obtain substantially all of the remaining benefits from, an asset. Applied to the principal vs agent question, an entity is a principal if it obtains control of any one of the following from the other party:
| What the entity controls | Illustration |
|---|---|
| A good or other asset, which it then transfers to the customer | A retailer buys stock from a manufacturer, holds it and sells it on |
| A right to a service to be performed by the other party, giving it the ability to direct that party to provide the service to the customer on its behalf | A facilities company contracts to clean a customer's offices and engages a subcontractor to do the work |
| A good or service from the other party that it combines with other goods or services to provide the specified good or service | A contractor integrates subcontracted components into a building it delivers |
Two points narrow the test.
Legal title alone is not control. An entity that obtains title only momentarily before it passes to the customer, commonly called flash title, does not necessarily control the good. The question is whether the entity could direct its use in that interval, for example by selling it elsewhere.
Using a subcontractor does not make an entity an agent. A principal may satisfy its performance obligation through another party. If the entity has the right to the service and directs the subcontractor, it remains the principal even though it performs none of the work itself.
Control, not risks and rewards
IAS 18 asked whether the entity bore the significant risks and rewards of the transaction. IFRS 15 asks whether it controls the specified good or service. Risks remain relevant only as evidence of control, through the indicators below.
Indicators of Control
Where control is not evident from the arrangement, IFRS 15 provides three indicators that an entity controls the specified good or service before transfer.
| Indicator | Evidence pointing to principal | Evidence pointing to agent |
|---|---|---|
| Primary responsibility for fulfilment | The customer looks to the entity if the good or service is defective or does not meet specifications | The terms direct the customer to the supplier for performance and remedies |
| Inventory risk | The entity buys before a customer order, commits to minimum volumes, or takes back returned goods at its own cost | The entity never holds the goods and unsold or returned items remain the supplier's |
| Discretion in establishing the price | The entity sets the selling price and earns a variable margin | The supplier sets the price and the entity earns a fixed fee or percentage |
The indicators are applied with judgement:
- They support the control assessment and do not override it. An entity that meets one indicator but plainly lacks control is still an agent.
- They are not weighted and not exhaustive. Their relevance depends on the nature of the specified good or service.
- Inspection, repackaging or modification of goods before onward supply suggests the entity holds the goods and directs their use.
- Pricing discretion carries less weight on its own. An agent may be free to discount its own commission, and a principal may face a market price it cannot influence.
Removed indicators
The original IFRS 15 also listed exposure to credit risk and consideration in the form of a commission. The 2016 clarifications removed both: an agent can bear credit risk on the amounts it collects, and the form of consideration says little about control.
Practical Example
Trailhead operates an online store selling outdoor equipment. A customer buys a tent for 10,000 and pays Trailhead at checkout. Trailhead's share is 1,500; the supplier's share is 8,500. The facts differ in two scenarios.
Scenario A: marketplace listing. The supplier lists the tent on Trailhead's platform, sets the selling price, ships directly from its own warehouse and handles returns. Trailhead collects the cash, keeps a 15% commission and remits the balance within 30 days.
Trailhead never controls the tent. It does not hold it, cannot redirect it to another customer, bears no inventory risk and does not set the price. It is an agent.
| On sale | Debit | Credit |
|---|---|---|
| Bank | 10,000 | |
| Payable to supplier | 8,500 | |
| Revenue (commission) | 1,500 |
The payable is settled when Trailhead remits the 8,500 to the supplier.
Scenario B: own stock. Trailhead buys the tent from the supplier for 8,500, holds it in its warehouse, sets its own selling price and accepts returns at its own cost.
Trailhead controls the tent before the customer does and meets all three indicators. It is a principal.
| On purchase and sale | Debit | Credit |
|---|---|---|
| Inventory | 8,500 | |
| Trade payables | 8,500 | |
| Bank | 10,000 | |
| Revenue | 10,000 | |
| Cost of sales | 8,500 | |
| Inventory | 8,500 |
The two outcomes compare as follows.
| Line item | Agent (A) | Principal (B) |
|---|---|---|
| Revenue | 1,500 | 10,000 |
| Cost of sales | - | (8,500) |
| Gross profit | 1,500 | 1,500 |
| Gross margin | 100% | 15% |
Across a year in which the platform processes 200,000,000 of sales, the difference is revenue of 30,000,000 or 200,000,000 for the same profit. If Trailhead runs both models, it reports each on its own basis, and the mix between them drives reported revenue growth.
Common Arrangements
The conclusion always depends on the terms, but the following patterns recur.
| Arrangement | Usual conclusion | Deciding factor |
|---|---|---|
| Online marketplace listing third-party goods | Agent | The seller fulfils the order, holds the stock and sets the price |
| Retailer or distributor selling its own stock | Principal | The entity holds inventory and bears the risk of unsold or returned goods |
| Travel business pre-purchasing flights or rooms it must pay for whether or not resold | Principal | It controls the right to the service before selling it (IFRS 15 Illustrative Example 47) |
| Booking platform or voucher seller with no commitment to the supplier | Agent | It arranges the service; the supplier sets the price and performs (Illustrative Example 48) |
| Service provider using subcontractors | Principal | It directs the subcontractor and is responsible to the customer (Illustrative Example 46) |
| Staffing business supplying workers it employs and directs | Principal | It is responsible for the service delivered |
| Recruitment business charging a placement fee | Agent | The candidate is employed by the customer; the business only introduces them |
| Advertising network placing ads on third-party sites | Depends on terms | Whether it commits to inventory of ad space and sets prices, or matches buyers and publishers |
A single entity often holds more than one of these positions. A retailer that sells its own stock and gift cards redeemable at partner stores is a principal for the first and usually an agent for the second.
Measuring and Timing Revenue
Principal
A principal recognises revenue at the gross amount of consideration it expects to be entitled to, applying the normal transaction price requirements for discounts, rebates and variable consideration. Amounts paid to the other party are costs, not a reduction of revenue.
Occasionally a principal does not know the price an intermediary charges the end customer, for example where a reseller sets its own price and does not disclose it. The principal then measures revenue at the consideration it receives from the intermediary, as it cannot estimate an amount it has no information about.
Agent
An agent recognises revenue at the amount of its fee or commission, which may be the net amount it retains after paying the other party. Revenue is recognised when the agent satisfies its own performance obligation, which is arranging the provision of the good or service. That can precede the other party's performance: a voucher seller acting as agent recognises its commission when the voucher is sold, not when the meal is served.
Cash an agent collects on behalf of the principal is not revenue. It is recognised as a liability to the principal until settled.
Amounts collected on behalf of third parties
The transaction price excludes amounts collected on behalf of third parties. VAT collected for the revenue authority is the most common example. Other taxes, such as excise duties, need their own assessment: where the entity is primarily liable for the tax, it forms part of revenue and cost rather than an amount collected for someone else.
Tax follows its own rules
The accounting conclusion does not determine the tax treatment. In South Africa, for example, section 54 of the VAT Act sets its own rules for supplies made through agents, which may differ from the gross or net presentation adopted under IFRS 15.
Presentation and Disclosure
The principal vs agent conclusion is a presentation matter for the income statement, but it also affects:
- the statement of financial position, where an agent carries payables to principals rather than inventory and trade payables;
- key ratios, including gross margin, inventory days and revenue-based covenants; and
- analysis of operating expenses under IFRS 18, where cost of sales is much smaller for an agent.
IFRS 15 requires disclosure of the nature of the goods or services the entity has promised, highlighting any arrangements in which it acts as an agent. Where the assessment required significant judgement, that judgement is disclosed as well. Entities that switch models, for example from reselling stock to operating a marketplace, explain the effect on revenue so that growth figures can be compared.
Receivables and payables arising from agency arrangements sit apart from contract assets and contract liabilities, which relate only to the entity's own performance obligations.
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Conclusion
The principal vs agent assessment reduces to one question, asked for each specified good or service: does the entity control it before it is transferred to the customer? If so, it is a principal and recognises revenue gross. If it only arranges for another party to provide it, it is an agent and recognises its fee or commission.
The indicators of primary responsibility, inventory risk and pricing discretion support that judgement but do not replace it. Profit is the same under either conclusion; revenue, margins and the statement of financial position are not.
Arrangements that bundle a service with the use of an asset raise a related question of what is being provided. Our guides to identifying a lease and non-lease components cover how those contracts are separated.
For clarification, guidance, or feedback on our article, please reach out to us at insight@leash.co.za.