Principal and agent Business considerations

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Principal versus agent considerations

A person or company might act for another company. In this case the first company is said to be an agent of the second company and the second company is described as the principal.

Principal An entity is a principal if it controls a promised good or service before it is transferred to a customer. However, an entity is not necessarily acting as a principal if it obtains legal title of a product just before legal title is transferred to a customer.

A principal is responsible for satisfying a performance obligation. It may do this by itself or it may engage another party (for example, a subcontractor) to help do this.

A principal recognises the gross amount of revenue to which it is entitled for goods and services transferred.

Agent An agent’s performance obligation is to arrange for the provision of goods or services by another party (the principal).

The agent is providing a selling service to the principal. The agent should not recognise the whole sale price of the goods but only the fee for selling them.

When an agent satisfies a performance obligation, it recognises revenue in the amount of any fee or commission to which it expects to be entitled in exchange for arranging for the principal to provide its goods or services.

An agent might sell goods for a principal and collect the cash from the sale. The agent then hands the cash to the principal after deducting an agency fee

 

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It is usually straightforward to decide if an entity is an agent or a principal.

The determination is based on the nature of the promise of a party in a contract. Indicators that an entity is an agent (and therefore does not control the good or service before it is provided to a customer) include the following:

 another party is primarily responsible for fulfilling the contract;

 the entity does not have inventory risk before or after the goods have been ordered by a customer, during shipping or on return;

 the entity does not have discretion in establishing prices for the other party’s goods or services and, therefore, the benefit that the entity can receive from those goods or services is limited;

 the entity’s consideration is in the form of a commission; and

 the entity is not exposed to credit risk for the amount receivable from a customer in exchange for the other party’s goods or services.

 

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Sale with a right to return Some contracts result in the transfer of control of a product to a customer but also grant the customer the right to return the product for various reasons (such as dissatisfaction with the product) and receive any combination of the following:

 a full or partial refund of any consideration paid;

 a credit that can be applied against amounts owed, or that will be owed, to the entity; and  another product in exchange. All of the following must be recognised when a product is sold with a right of return:

 revenue for the transferred products in the amount of consideration to which the entity expects to be entitled (i.e. revenue would not be recognised for the products expected to be returned);

 a refund liability; and

 an asset (and corresponding adjustment to cost of sales) for its right to recover products from customers on settling the refund liability

 

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Repurchase agreements A repurchase agreement is a contract in which an entity sells an asset and also promises or has the option (either in the same contract or in another contract) to repurchase the asset.

A customer does not obtain control of the asset when the selling entity has an obligation or a right to repurchase the asset.

Even though the customer may have physical possession of the asset, the customer is limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from the asset.

If the repurchase agreement is a financing arrangement, the entity must continue to recognise the asset and also recognise a financial liability for any consideration received from the customer.

The difference between the amount of consideration received from the customer and the amount of consideration to be paid to the customer is recognised as interest