Learning Outcomes
After reading this article, you will be able to determine whether an entity acts as principal or agent under IFRS 15, and understand the impact on revenue measurement. You will also know how to identify, capitalize, and amortize contract costs, and explain related disclosures, all in alignment with ACCA SBR assessment requirements.
ACCA Strategic Business Reporting (SBR) Syllabus
For ACCA Strategic Business Reporting (SBR), you are required to understand how revenue is recognized under IFRS 15, including complex contract arrangements. In particular, you should focus on:
- Evaluating and applying the principal versus agent assessment when recognizing revenue
- Identifying and measuring contract costs, including asset recognition and amortization
- Recognizing and measuring revenue, including circumstances involving variable consideration and modifications
- Disclosing the nature, amount, timing, and uncertainty of revenue and cash flows from contracts with customers
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- True or False? An agent recognizes the gross amount of consideration received from a customer as revenue.
- A travel agency sells holiday packages on behalf of airlines and hotels, and earns a 10% commission per sale. The agency sets the selling price. Under IFRS 15, is the travel agency likely acting as principal or agent?
- When should the costs of obtaining a contract be capitalized under IFRS 15?
- Briefly explain how contract fulfillment costs are treated if they relate to a specific contract but are also within the scope of IAS 2 Inventories.
Introduction
IFRS 15 Revenue from Contracts with Customers provides guidance not only on when to recognize revenue but also on how much to recognize. A key complexity arises where more than one party is involved in providing goods or services to the customer. The standard requires careful judgment to determine whether an entity is a principal—controlling the specified goods or services before transfer—or an agent, arranging for another party to supply the goods or services.
This decision directly impacts the amount of revenue recognized. Principals record gross revenue; agents, only their fee or commission. In addition to this, IFRS 15 sets out specific requirements for accounting for contract costs, including which costs can be capitalized and the timing of expense recognition.
Key Term: Principal
An entity that controls the specified goods or services before they are transferred to the customer and is responsible for fulfilling the promise in the contract.Key Term: Agent
An entity that arranges for goods or services to be provided by another party but does not control those goods or services before transfer to the customer.Key Term: Contract Costs
Incremental costs of obtaining or fulfilling a contract with a customer that an entity expects to recover.
Principal vs Agent Assessment
When analysing a contract, IFRS 15 requires an entity to decide whether it acts as principal or agent for each specified good or service promised to the customer. This assessment must be made separately for each distinct performance obligation in a contract.
Control Before Transfer
An entity is a principal if it controls the promised goods or services before they are transferred to the customer. Key indicators of control include the responsibility for acceptance, risk of inventory obsolescence, and primary responsibility towards the customer.
An agent does not control the goods or services but instead facilitates provision by another party. An agent’s revenue is limited to the fee or commission retained.
Key Term: Control (in principal-agent context)
The ability to direct the use of, and obtain substantially all of the remaining benefits from, the specified goods or services before transfer to the customer.
Indicators for Principal or Agent
IFRS 15 provides guidance and examples to help determine the correct role. Common indicators include:
Indicators the entity is a principal:
- The entity is primarily responsible for fulfilling the contract and providing the goods or services.
- The entity has discretion in setting prices.
- The entity holds the inventory risk before or after customer order.
Indicators the entity is an agent:
- Another party is primarily responsible for fulfilling the contract.
- The entity earns a predetermined fee or commission.
- The entity does not have inventory risk.
Worked Example 1.1
A ticketing platform sells concert tickets on behalf of venues. Customers pay through the platform, which passes the proceeds (less a 12% handling fee) to the venue. The platform does not set ticket prices. Who is the principal?
Answer:
The platform is an agent. The venue sets the price and is responsible for event delivery. The platform does not control the tickets before they are transferred to the customer and earns only a handling fee.
Worked Example 1.2
Retailer A sells electronics via its website. Products are held in A’s warehouse, and A arranges shipping. If a customer returns a product, A accepts the return and bears the risk of reselling the item. Is Retailer A principal or agent?
Answer:
Retailer A is a principal. It controls the product before sale, is responsible for customer satisfaction, and bears inventory and return risks.
Exam Warning
In the exam, do not simply list indicators—apply them directly to the facts. Examiners look for a clear link between the facts and your conclusion, supported by reference to control.
Contract Costs
IFRS 15 requires entities to recognize an asset for contract costs when certain criteria are met, rather than expensing all such costs immediately.
Costs of Obtaining a Contract
Only incremental costs—those incurred solely because a contract was obtained—can be capitalized. Examples include sales commissions paid only on successful contracts. Capitalization is allowed if recovery is expected.
Key Term: Incremental Costs of Obtaining a Contract
Costs that would not have been incurred if the contract had not been obtained (e.g., winning commissions).
Costs to Fulfill a Contract
Fulfillment costs are capitalized as a contract asset if:
- The costs relate directly to a specific contract,
- They generate or improve resources to satisfy the contract, and
- They are expected to be recovered.
If the costs relate instead to inventory (IAS 2), property, plant and equipment (IAS 16), or intangible assets (IAS 38), those standards take precedence.
Key Term: Contract Asset
An entity’s right to consideration in exchange for goods or services that have been transferred to the customer, but where the right is conditional on something other than the passage of time.
Amortization and Impairment
Capitalized contract costs are amortized on a systematic basis as the goods or services are provided. At each reporting date, the asset must be reviewed for impairment; unrecoverable amounts are expensed.
Worked Example 1.3
A company pays a sales manager a $15,000 bonus for signing a five-year service contract with a new client. The bonus is only paid if the client contract is won. Should this bonus be capitalized?
Answer:
Yes, if the company expects to recover the cost from the contract. The bonus is incremental, incurred solely to obtain the contract, and should be capitalized and amortized as revenue is earned.
Exam Warning – Contract Costs
Do not capitalize general overheads or costs that would have been incurred regardless of the contract's success—for example, legal due diligence or pre-sales salaries. Only incremental and directly attributable costs that are expected to be recovered may be treated as a contract asset under IFRS 15.
Summary
Determining whether to account as a principal or agent affects the measurement of revenue and disclosures. Carefully assess who controls the specified goods or services before transfer. Agents recognize only the commission as revenue; principals recognize gross revenue. For contract costs, only incremental costs of obtaining a contract and direct fulfillment costs expected to be recovered may be capitalized, subject to subsequent amortization and impairment.
Key Point Checklist
This article has covered the following key knowledge points:
- Distinguish between principal and agent roles in IFRS 15 contracts
- Apply control indicators to principal/agent decisions
- Recognize when to capitalize incremental and fulfillment contract costs
- Explain amortization and impairment of contract cost assets
- Identify common errors in principal/agent and contract cost assessments
Key Terms and Concepts
- Principal
- Agent
- Contract Costs
- Control (in principal-agent context)
- Incremental Costs of Obtaining a Contract
- Contract Asset