Article:

IFRS 15 for the TMT industries – Principal vs. agents

27 June 2018

Advertising and media sales often involve a vendor engaging external suppliers to supply content. A key question is whether the vendor should account for revenue as a principal (and record gross amounts for revenue and costs) or as an agent (in which case the amount recorded is the net fee or commission amount retained).

IFRS 15 includes detailed guidance for determining whether a vendor is acting as a principal by selling specified goods or services to its customer, or is instead acting as an agent by arranging for another party (or parties) to provide those goods or services. 

The starting point is that if the vendor controls the goods and services before they are transferred to its customer, then the vendor is a principal.  However, this may not be the case if, for example, the vendor obtains legal title of the goods or services only momentarily before they are transferred to a customer.

The analysis also becomes more complex if the entity engages someone else to satisfy some, or all, of the performance obligations on its behalf. In such cases, the entity would be acting as principal if it obtains control of any of the following:

A good or other asset from the other party that it then transfers to the customer
OR
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 services to the customer on the entity’s behalf
OR
A good/service from the other party that it then combines with other goods/services in providing the specified good/service to the customer

Other indicators that a vendor is acting as principal include, but are not limited to:

  • The vendor is primarily responsible for fulfilling the promise to provide the goods/services
  • The vendor has inventory risk before the goods/services have been transferred to the customer, or after, for example if the customer has a right to return the goods or services to the vendor
  • The vendor has discretion in establishing prices for the goods/services.

Although many entities in the media sector have previously considered whether they act as a principal or as an agent, the more prescriptive guidance in IFRS 15 may lead to changes in approach.

Example 1 (Agent)

Background

A customer engages with Advertising Co. to buy $1,000 worth of advertising in a newspaper for a period of time.

Advertising Co. is entitled to a 10% commission on the sales price which is retained by them when they pay the newspaper.

Prices for the advertising are set by the newspaper company and Advertising Co. requires payments from customers before they order the advertising from the newspaper company.

The order is non-refundable. The customer sends their advertising requirements directly to the newspaper and any issues are dealt with between the newspaper and customer.

Question
Is Advertising Co. acting as a principal or agent? How should it account for the transaction?

Answer
Advertising Co. is acting as an agent because:

  • The newspaper company is responsible for fulfilling the promise to run the advertisements and Advertising Co. assumes no risk for the performance of the service
  • Advertising Co.’s consideration is in the form of commission
  • Advertising Co. has no discretion in setting prices
  • Advertising Co. has no inventory risk because it only places orders for advertisement placement once it has received payment from its customer, and
  • Advertising Co. merely arranges for the services to be performed by the newspaper. It does not obtain control of the advertising space in the newspaper before the customer ads are placed.

Advertising Co. should therefore recognise the net revenue, i.e. commission received of $100 (10% x $1,000).

Dr Cash $100  
Cr Revenue   $100

Example 2 (Principal)

Background

A customer engages with Advertising Co. to purchase a quarter page of advertising space in the XYZ Daily Newspaper for 365 days for $100,000.

Advertising Co. pre-purchases five full pages of space from the XYZ Daily Newspaper for the same period at a cost of $50,000, which it then on-sells to advertisers.

Advertising Co. negotiate rates for the advertising space directly with customers.

The customer sends their advertising requirements directly to the newspaper.

If there are any problems with the publication of advertisements by the XYZ Daily Newspaper, Advertising Co. will advocate on the customer’s behalf.

Question
Is Advertising Co. acting as a principal or agent? How should it account for the transaction?

Answer
In this scenario, Advertising Co. is acting as principal because:

  • Advertising Co. is responsible for fulfilling the promise to run the advertisements and will advocate on behalf of customers if there are problems with publication
  • Advertising Co. has the discretion to set its own selling prices
  • Advertising Co. has inventory risk because it is committed to paying the XYZ Daily Newspaper $50,000 annually for five full pages of advertising, regardless of whether they on-sell to customers, and
  • Although it appears that Advertising Co. is merely arranging for the advertising services to be performed by the newspaper, it does control the advertising space in the newspaper before the customer ads are placed, and it also has the ability to direct the newspaper to place other ads in that space instead.

Advertising Co. should therefore recognise the gross revenue, i.e. $100,000.

Dr Cash $100,000  
Cr Revenue   $100,000

Current practice under IAS 18

The current practice under IAS 18 is similar, but there are slightly different requirements for IFRS 15, namely the concept of ‘control’ which will change the way an entity makes its assessment.

Practical implications on systems and processes  

Some of the practical implications on systems and processes for Advertising Co. include:

  • Processes to identify if an entity is an agent or principle
  • Systems to account for the revenue net of costs if acting as an agent.