By Surachai Damnoenwong, Audit Director
IFRS 15 Revenue from contracts with customers in respect of Principal or Agent
With reference to agent-principal relationships, IFRS 15 states that an entity should NOT include the amounts collected on behalf of others into its revenue, because these do not increase their equity because the entity keeps only the commission and transfers the rest to the entity responsible for that service, or a principal.
Sometimes it is difficult to assess properly and conclude correctly whether this represents an agent or a principal.
Basically, an entity is an agent if its responsibility is limited to arranging or mediating the provision of goods or services for another party.
IFRS 15 give us a guidance of what an entity can use for its own assessment.
An entity is acting as a principal when:
- An entity is responsible for services or goods.
Therefore, it is an entity, which guarantees quality of goods/services, and it is an entity, which is responsible for guarantee repairs, any corrections/modifications, or post-delivery services. - It is an entity, which bears inventory risks.
For example – if an entity’s goods are stored in a warehouse and are stolen it is the entity’s responsibility for the theft. This applies even when the goods are stored in the warehouse of another entity.
Alternatively, an entity carries the loss from any unsold and obsolete inventory items. - It’s an entity which establishes prices for the goods or services.
If an entity can influence or set the price of the goods/services, directly or indirectly, then it indicates the entity as the principal.
IFRS 15 adds that an agent gets its remuneration in the form of a commission.
Sometimes, one of the above criteria is met and the other one is not met – in a similar situation an entity should carefully consider whether significant risks and rewards of ownership, or control over goods or services were transferred or not.
Example #1 – Goods
ABC is a shop selling bicycles, both new and used. There are 2 main selling procedures:
- New bikes
ABC buys new bikes from their manufacturers. Once the bikes are bought, they are delivered to ABC’s warehouse or store and are offered to the end customers.
Normally, ABC pays for these bikes within 30 days from their delivery to the suppliers.
The bikes remain in ABC’s store or warehouse until they are sold. As the value of bike inventories is quite high, ABC took out an insurance policy to cover all risks.
It’s ABC which sets the price of the new bikes and decides about any discounts or promotions.
New bikes come with a 2-year guarantee for the main parts. It is the producer who sets the guarantee repairs terms, but it is ABC who deals with the end customer and provides post-delivery support.
- Used bikes
ABC gets the used bikes from their previous owners (let’s call them “sellers”). The seller brings a bike to ABC’s store and leaves it there to offer them to customers. At that point, the seller does not get any cash.
The sellers usually set selling prices of the used bikes, but ABC has the right to adjust the price by pre-approved percentages and the sellers must be informed about the adjustments.
When ABC sells bikes to new customers, ABC informs the sellers about the transactions. The sellers visit ABC’s store and get 90% of revenue from the sales of his used bikes (the remaining 10% margins are for ABC).
When bikes are not sold within 180 days, the sellers must take them back from ABC.
Used bikes are also covered by the same insurance policy as the new bikes. The sellers do not pay any insurance premium – instead, it is included in the remuneration for ABC (10% of selling price).
Used bikes do not come with any guarantees whatsoever.
How should ABC recognize revenues from the sales of new and used bikes?
Solution #1- Goods
- New bikes
Assess the criteria to determine whether ABC acts as an agent or as a principal.
The primary question here is whether all or at least the majority of the risks and rewards of ownership of the new bikes were transferred to ABC or not. In accordance with IFRS 15, the control over the new bikes was transferred because:
- The Inventory risk sits clearly with ABC – if something happens to the bikes, its ABC’s loss. That is also, why ABC took out an insurance policy.
- Producers are no more involved in the control of the new bikes, as its ABC who sets prices, provides post-delivery services, etc.
The producers only make guarantee repairs and for that purpose, they probably recognize some provision based on past statistics, but it only means that the producers retained the minor risks. It does NOT mean that producers retained control over the bikes. - There is no customer credit risk as the customers pay for the bikes immediately when taking them from the store.
Conclusion – ABC accounts for the revenue from the sales of bikes in gross amounts as it acts as a principal.
- Used bikes
The situation is different regarding used bikes because clearly, it seems that not all the risks and rewards of ownership / control were transferred to ABC when sellers brought their used bikes to the store.
Assess the agent/principal criteria:
- It’s difficult to say who is responsible for the goods sold, as there is no guarantee and nothing said about the post-delivery service, but we can assume that ABC would not take any responsibility (of course, in reality, it’s necessary to examine it).
- Inventory risk is borne by the sellers. The reason is that the bikes are returned to sellers if not sold. Also, bikes are insured, but sellers pay for the insurance within the remuneration to ABC.
- Sellers have the major decision making powers when setting the prices.
- Again, customer credit risk is out of question here as customers pay cash.
Conclusion – ABC accounts for the sale from used bikes as for the “agency” transaction – i.e. in net amounts, as it acts as an agent.
Source of information: on the www.cpdbox.com website
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