It is common for companies to partner with other organizations to provide goods or services for their customers. The new Revenue from Contracts with Customers(codified as ASC 606) rules recognize this fact, and provide recommendations for how you should handle the revenue associated with these products and services. It boils down to determining whether you are acting as the principal or the agent in the transaction. While this may sound simple enough, like many aspects of ASC 606, it gets complicated.
What is my role?
A fundamental provision in ASC 606 is the identification of your performance obligations (deliverables, as we used to call them) in a contract. In a single contract with multiple performance obligations, it is conceivable that your firm could act as the principal for some of the obligations and the agent for others. Generally, the rules say that if you are directly providing the good or service, you are the principal, and if you are arranging for the good or service to be provided, you are the agent.
Below are some tips to help clarify your role:
You are the principal if:
- You control the goods or services before transfer to the customer (even if you first took control from another party).
- You are directing another party to provide a service for the customer on your behalf.
- You combine the goods and services from another party with your own goods and services before transfer to the customer.
You are the agent if:
- You do not directly control the goods or services before transfer to the customer (you have no inventory risk).
- You are responsible for fulfilling the promise to provide the goods or services (an example would be where you bear the responsibility for the goods or service meeting customer specifications).
- You receive a commission for your activities.
You may be wondering about price determination. Intuitively it seems that if you determine the price, you must be the principal, but this is not necessary true.
What about that revenue recognition?
Under ASC 606, if you are acting as the principal for a specified good or service, you should recognize revenue as you pass control to the customer. If you are acting as the agent for a good or service, you should recognize revenue when you promise to arrange for the provision of the good or service to the customer. This is a significant, if subtle, difference. When acting as the agent, for example, you might recognize revenue at the customers’ point of purchase, rather than at the point of delivery.
Talk to the pros
ASC 606 speaks a lot to the topic of principal versus agent, and this post contains only a very high level overview of this complex issue. We urge our clients to consult with a tax professional to ensure compliance. BTerrell
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