Principal vs Agent? GAAP Revenue Recognition Criteria (ASC 606)
Should you report revenue gross as a principal or net as an agent? GAAP revenue recognition criteria related to principal vs agent determination is changing under ASC 606 because of the issuance of ASU 2016-08, Principle versus Agent Considerations (Reporting Revenue Gross versus Net). I needed this guidance because I was very confused by a recent purchase I made on Walmart’s website. Using this “real-life” example, this post explores the new revenue recognition criteria related to principal vs agent determination under ASC 606.
Example of principal vs agent dilemma
I purchased pair of Beats by Dr. Dre Powerbeats 2 wireless in-ear headphones as a prize for our company’s Super Bowl squares game (other prizes included a Yeti cooler, $150 gift certificate for a date night, and an Apple Watch). After my purchase, I received the following email from Walmart:
The email clearly states the item “ships from Incredible Cellular LLC.” I was confused. Who the heck did I buy these headphones from? I picked Walmart figuring if I ran into any problems they always refund your purchase “no questions asked.” However, the fine print clearly said:
“If you bought your item from a Marketplace Retailer on our site, please contact them for return instructions. Items purchased from a Marketplace Retailer cannot be returned to a Walmart store or to Walmart.com; they must be returned to the Marketplace Retailer in accordance with their return policy.”
As any good accountant would do, it got me thinking:
“How should Walmart recognize and present revenue from this transaction?”
Exciting life I lead, huh!
Why does it matter who is the principal and who is the agent?
Before we get into the new guidance within ASC 606 (which was amended by ASU 2016-08), let’s talk about why it matters. Let’s assume:
- I paid $110.00 to Walmart for the headphones, shipping was free, and there was no sales tax collected on the transaction (Shhhh…don’t tell tax authorities).
- Incredible Cellular set the sales price and Walmart agreed to pay Incredible Cellular 85% of the sales price collected. In our case, Walmart owes Incredible Cellular $93.50 ($110.00 x 85%).
- Incredible Cellular is responsible for fulfilling the order and delivery.
- The headphones are shipped from Incredible Cellular’s warehouse.
This transaction contributes $16.50 ($110.00 less $93.50) to Walmart’s bottom line. However, should Walmart present the transaction gross or net?
This transaction results in operating income of $16.50, regardless of how it is presented in the income statement. However, which presentation looks better? Obviously, revenues are higher using gross presentation.
Guidance for principal vs agent considerations (ASU 2016-08)
ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net) amends revenue recognition guidance within ASC 606 for these types of transactions. To determine the nature of its promise to the customer, the entity should:
- Identify the specified goods or services to be provided to the customer; and
- Assess whether it controls each specified good or service before that good or service is transferred to the customer.
An entity is a principal if it controls the specified good or service before that good or service is transferred to a customer. If an entity does not control the good or service before it is transferred to the customer, the entity is an agent in the transaction.
Definition and indicators of control
Control is defined within step 5 of ASC 606. Control of an asset refers to the ability to direct the issue of, and obtain substantially all the remaining benefits from, the asset. Control includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset. The benefits of an asset are the potential cash flows (inflows or savings from outflows) that can be obtained directly or indirectly from using, selling, pledging, or holding the asset.
It is not always clear whether the entity obtains control of the specified good or service. Luckily, ASU 2016-08 provided the following three indicators of control that can be useful in making this determination:
- The entity is primarily responsible for fulfilling the promise to provide the specified good or service.
- The entity has inventory risk before the specified good or service has been transferred to a customer, or after transfer of control to the customer (for example, if the customer has a right or return).
- The entity has discretion in establishing the prices for the specified goods or service.
Solution: Is Walmart the principal or the agent?
So, what do you think? Should Walmart present this sale gross or net?
Walmart should present this transaction net as they appear to be the agent in the transaction. Walmart does not control the headphones before they are shipped. Furthermore:
- Incredible Cellular, not Walmart, is responsible for fulfillment.
- Incredible Cellular, not Walmart, has the inventory risk both before and after shipment, as the goods are shipped from their warehouse and they are responsible for returns.
- Incredible Cellular sets the sales price.
Clearly, Walmart is the agent and, as such, earns a 15% commission on the sale. Therefore, net presentation within the income statement is appropriate. Interestingly, this Walmart transaction is almost identical to the example used within ASU 2016-06 (Example 45) found in paragraphs 606-10-55-317 through 55-319.
Closing thoughts
I hope this “real-life” example helps you understand the new principle vs agent guidance within ASC 606. By the way, I gave the headphones a 5-star review and bought another pair for myself!
Need help revenue recognition? Head over to our Revenue Recognition Topic Page where we discuss accounting issues, GAAP differences, and more! Need a comprehensive training on revenue recognition under U.S. GAAP? Check out our ASC 606: Revenue from Contracts with Customers eLearning course collection (7 courses; 5.5 CPE).
About GAAP Dynamics
We’re a DIFFERENT type of accounting training firm. We view training as an opportunity to empower professionals to make informed decisions at the right time. Whether it’s U.S. GAAP, IFRS, or audit training, we’ve trained thousands of professionals since 2001, including at some of the world’s largest firms. Our promise: Accurate, relevant, engaging, and fun training. Want to know how GAAP Dynamics can help you? Let’s talk!
Disclaimer
This post is for informational purposes only and should not be relied upon as official accounting guidance. While we’ve ensured accuracy as of the publishing date, standards evolve. Please consult a professional for specific advice.
