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Principal versus agent
Section 23.4 deals with the revenue recognition for a company acting as principal or agent.
‘An entity is acting as an agent when it does not have the exposure to the significant risks and rewards associated with the sale of goods or the rendering of services. One feature indicating that an entity is acting as an agent is that the amount the entity earns is predetermined, being either a fixed fee per transaction or a stated percentage of the amount billed to the customer’ (Appendix I FRS 102).
‘An entity is acting as a principal when it has exposure to the significant risks and rewards associated with the sale of goods or the rendering of services. Features that indicate that an entity is acting as a principal include:
- the entity has the primary responsibility for providing the goods or services to the customer or for fulfilling the order, for example by being responsible for the acceptability of the products or services ordered or purchased by the customer;
- the entity has inventory risk before or after the customer order, during shipping or on return;
- the entity has latitude in establishing prices, either directly or indirectly, for example by providing additional goods or services; and
- the entity bears the customer’s credit risk for the amount receivable from the customer.’ (FRS 102 Appendix I).
Example 4: Principal vs Agent
Company A purchases goods from Company B as part of a distribution agreement. The distribution agreement states that:
- Company A takes the inventory into its warehouse and transports and invoices the goods to the final customer but also packages these
- Where Company A has excess stock it can be returned to Company B without any penalty
- Company A is responsible for insuring the goods while in inventory however obsolete stock can be returned
- Company A has no right in determining the selling price, this is dictated by Company B. The mark up included in the sales price by Company A is dictated by Company B – markup is set at 50% of the sales price.
- In the event of default in payment by the customer after all avenues have been exhausted Company B bears the risk of bad debts
During the month Company A sold CU100,000 of the products. The company purchased CU80,000 in stock from Company B which existed at year end.
Based on the evidence available, Company A is acting as agent as it has no say in determining the selling price, bears no inventory risk nor credit risk. Company A would therefore only recognise the net amount as revenue (i.e. the sales price less the cost of purchase of the goods). Company B is the principal and should not recognise any revenue until the Company A sells the goods on to the final customer, it should continue to carry these in stock as it is akin to a consignment stock agreement.
The journals required in the month for Company A are:
|
|
CU |
CU |
|
Dr Debtors |
33,333 |
|
|
Cr Revenue (CU100,000 being the sales price less CU66,667 being the purchase price as Company A earns a 50% mark-up) |
|
33,333 |
Being journal to recognise the net commission earned on the sale
The journals required in the month for Company B are:
|
|
CU |
CU |
|
Dr Debtors |
100,000 |
|
|
Cr Revenue |
|
100,000 |
Being journal to reflect the amounts owed from Company A. Note the inventory of CU53,333 (CU80,000- mark up of CU26,667) is kept in the books of Company B as this inventory is still under the control of Company B.
If in the above example, Company A held the inventory risk in full or could determine the selling price this would usually indicate that it is acting as principal and Company A would then show inventory on the balance sheet and the gross revenue in the revenue line and the cost of the products in cost of sales.
Example 5: Principal vs agent
Company A is a retailer that deals in cash so there is no credit risk. The company sells the following products:
| Classification | |
| Mobile phone e-top up’s which are printed from a machine as required. | Agent |
| Stamps (bought in bulk by the retailer and bears the risk if they are not sold) | Principal |
| National lottery tickets which are printed from a machine as required | Agent |
| Scratch cards (bought in bulk by the retailer and bears the risk if they are not sold) | Principal |
As can be seen where the retailer sells items which are sold in electronic form the seller is acting as an agent as it bear no risk i.e. it does not need to hold inventory of the items and there is no risk of obsolescence, it bears no credit risk as cash is received when sold. In these instances, the sales commission received should be recognised as turnover.
Where there is a tangible product and where the retailer is required to hold stock and bears the risk of loss if these are damaged or stolen then they are acting as a principal. Therefore the gross sales should be recognised in revenue and the cost of the products shown in cost of sales.
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