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Heads Up — FASB proposes amendments to new revenue standard’s guidance on principal-versus-agent considerations

Published on: Sep 01, 2015

Download PDFVolume 22, Issue 30

by Joe DiLeo and Nick Tricarichi, Deloitte & Touche LLP

Introduction

On August 31, 2015, the FASB issued a proposed ASU1 that would amend the Board’s May 2014 revenue standard2 (the “new revenue standard”) to address issues raised regarding how an entity should assess whether it is the principal or the agent in contracts that include three or more parties (“principal-versus-agent considerations”). In particular, stakeholders have questioned (1) how to determine the unit of account (i.e., whether it should be at the contract level or the performance-obligation level), (2) whether the related indicators in the new revenue standard are intended to assist in a single evaluation of control or represent an additional evaluation, and (3) how certain indicators are related to the new revenue standard’s general control principle.

Editor’s Note: The amendments outlined in the proposed ASU clarify, rather than change, the core principle of the principal-versus-agent considerations.

This Heads Up summarizes the key provisions of the proposed ASU and contains two appendixes. Appendix A lists the proposed ASU’s questions for respondents. Appendix B reproduces illustrative examples from the proposed ASU that would amend or supplement the new revenue standard’s existing examples.

Comments on the proposed ASU are due by October 15, 2015.

Editor’s Note: In July 2015, the IASB issued an exposure draft that includes proposed amendments to the principal-versus-agent guidance and related illustrative examples in IFRS 15,3 the IASB’s counterpart to the FASB’s new revenue standard. Such proposed amendments are identical to those in the proposed ASU. Comments on the IASB’s exposure draft are due by October 28, 2015.

Analyzing Promises in a Contract With a Customer

The proposed ASU would clarify that an entity should evaluate whether it is the principal or the agent for each specified good or service (i.e., each good or service or bundle of distinct goods or services that is distinct) promised in a contract with a customer. In addition, the proposal would add guidance to help entities determine the nature of promises in a contract. Specifically, the proposed guidance would require an entity to (1) identify the specified goods or services (or bundles of goods or services), including rights to goods or services from a third party, and (2) determine whether it controls each specified good or service (or right to a third-party good or service) before each is transferred to the customer. If the entity controls the specified good or service before transfer, it would be the principal; otherwise, it would be an agent that arranges for another party to provide the specified good or service. Further, the proposed ASU would clarify that an entity may be the principal with respect to certain distinct goods or services in a contract but an agent with respect to others.

Control Considerations

The proposed ASU would add clarifying guidance on the types of goods or services that a principal may control. Specifically, ASC 606-10-55-37A would be added to provide the following guidance:

When another party is involved in providing goods or services to a customer, an entity that is a principal obtains control of:
a. A good or another asset from the other party that it then transfers to the customer
b. A right to a service to be performed by the other party, which gives the entity the ability to direct that party to provide the service to the customer on the entity’s behalf
c. A good or service from the other party that it then combines with other goods or services in providing the specified good or service to the customer. If an entity provides a significant service of integrating goods or services provided by another party into the specified good or service for which the customer has contracted, it controls the specified good or service before that good or service is transferred to the customer. In that case, the entity first obtains control of the good or service from the other party and directs its use to create the combined output that is the specified good or service.

In addition, the proposed ASU would reframe the indicators in the new revenue standard to illustrate when an entity may be acting as a principal instead of when an entity acts as an agent. Further, the proposed ASU would amend each indicator to include explanatory language on how the indicator is related to the control principle. Specifically, the proposed ASU would provide the following indicators of when an entity acts as a principal:

  • “The entity is primarily responsible for fulfilling the promise to provide the specified good or service“ to the customer (including responsibility for determining whether the other party’s good or service is acceptable) — The proposed ASU notes that such responsibilities on the part of the entity may demonstrate that the other party to the contract is acting on the entity’s behalf.
  • The entity has inventory risk before or after the specified good or service is transferred to the customer — The proposed ASU further notes, for example, that obtaining (or committing to obtain) the specified good or service before the entity obtains a contract with the customer “may indicate that the entity has the ability to direct the use of, and obtain substantially all of the remaining benefits from, the good or service before it is transferred to the customer.”
  • “The entity has discretion in establishing prices for the specified good or service,“ which may indicate that it had “the ability to direct the use of that good or service” when the contract was negotiated — However, the proposed ASU notes that an agent may also have discretion in setting prices (e.g., “to generate additional revenue from its service of arranging for goods or services to be provided by other parties to customers”).
  • The entity is exposed to credit risk for the amount receivable for the specified good or service transferred to the customer — The proposed ASU cites an example in which the entity is required to pay the other party in the transaction for a specified good or service to the customer regardless of whether the customer pays the entity. Such a situation may indicate that the entity is directing the other party to provide the specified good or service to the customer on its behalf. However, the proposed ASU notes that there could be situations in which an agent chooses “to accept credit risk as part of its overall service of arranging for the provision of the specified good or service” to the customer.

The proposed ASU would not give any indicator more weight than others in the assessment of whether the entity is the principal or the agent. However, it states that the control indicators may be more or less relevant to the assessment of control depending on the nature of the specified good or service in a particular contract.

Overview of Illustrative Examples

The proposed ASU would amend certain illustrative examples in the new revenue standard (and adds new ones) to clarify how an entity would assess whether it is the principal or the agent in a revenue transaction. The table below summarizes the amended and new examples proposed. Appendix B reproduces each of the examples from the proposed ASU.

Proposed Example Nature of Example
Example 45 (amended) — demonstrates that the entity is an agent In addition to illustrating how an entity would identify the specified goods or services and perform the related control assessment for each, Example 45 as amended would clarify that an entity’s consideration of the indicators is complementary to (rather than different or separate from) its assessment of whether it controls the goods or services before they are transferred to the customer.
Example 46 (amended) — demonstrates that the entity is a principal Like Example 45 in the proposed ASU, Example 46 as amended would illustrate how an entity would identify the specified goods or services and perform the related control assessment for each. Under the proposed ASU, Example 46 would also clarify that an entity may not need to consider the indicators when its evaluation of whether it controls the good or service is conclusive.
Example 46A (new) — demonstrates that the entity is a principal The proposed ASU would add this example to illustrate how an entity should apply the guidance on principal-versus-agent considerations to a transaction involving services.
Example 47 (amended) — demonstrates that the entity is a principal The proposed ASU would amend Example 47 to clarify that the nature of the specified good or service to be provided to the customer is a right that the entity controls. As amended, the example would illustrate how an entity should assess whether it controls the specified good or service when that good or service is a right. In addition, the amended example would demonstrate that some, but not all, of the indicators may be relevant to an entity’s assessment of whether it controls a right.
Example 48 (amended) — demonstrates that the entity is an agent Like proposed amended Example 47, Example 48 as amended would illustrate how an entity should apply the guidance on principal-versus-agent considerations when the specified good or service is a right. However, amended Example 48 would highlight when an entity acts as an agent because it does not control the right before transfer to the customer.
Example 48A (new) — demonstrates that the entity is both a principal and an agent in a single contract This proposed new example would illustrate that there may be more than one specified good or service in a contract and that an entity must assess each specified good or service separately to determine whether it controls each good or service before transfer to the customer. The entity in the proposed example concludes that it is a principal with respect to one of the specified goods or services in the contract and an agent with respect to the other specified good or service.

Appendix A — Questions for Respondents

Please see Appendix A in the attached PDF.

Appendix B — Illustrative Examples

Please see Appendix B in the attached PDF.

____________________

1 FASB Proposed Accounting Standards Update, Revenue From Contracts With Customers (Topic 606): Principal Versus Agent Considerations (Reporting Revenue Gross Versus Net).

2 FASB Accounting Standards Update No. 2014-09, Revenue From Contracts With Customers.

3 IFRS 15, Revenue From Contracts With Customers.

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