Accounting for Revenue - Principal Versus Agent Considerations for Software Resellers
ASIC selects and evaluates a sample of published financial reports, based on perceived risk, including where there are potential issues in relation to selection accounting policies, including revenue recognition policies. ASIC recently caused a large ASX listed software reseller to restate its 2023 financial statements by over $1.6 billion following a query raised under ASIC’s financial reporting surveillance program in relation to revenue recognition.
Background
ASIC questioned the entities revenue recognition policy from contracts of sale of software licences as principal, rather than as an agent. When an entity acts as agent, but recognises the full amount of revenue in relation to a product or service it merely on-sells, it can misrepresent the size of the business and its level of profitability.
The company reassessed its policy, having regard to guidance issued by the IFRS Interpretations Committee (IFRIC) relating to software reseller to an agent basis of presentation and restated its historical results to conform with the new policy.
Where more than one party is involved in providing goods or services to a customer, IFRS 15 Revenue from Contracts with Customers, requires the entity to determine whether it provides the specified goods or services itself (as the principal) or whether it arranges for those goods or services to be provided by another party (the entity is an agent). This requires an entity to assess whether it controls each good or service before it is transferred to the customer.
An entity is an agent where it does not “control” the specified good or service provided by another party before being transferred to the customer. Control refers to the ability to direct the use of and to obtain substantially all of the benefits. IFRS 15 provides indicators of whether an entity has control of a good or service, including having:
primary responsibility for fulfilling the promise to provide the specified good or service
inventory risk before the specified good or service has been transferred to the customer or after transfer of control to the customer
discretion in establishing the price for the specified good or service.
The reseller needs to assess whether it obtains control of the software licences from the software developer before they are transferred to the customer. That assessment requires consideration of the terms and conditions of the contracts between the reseller and the customer, the reseller and the software developer and the software developer and the customer.
As the software developer is responsible for the software’s functionality, as well as for issuing and activating the licences, the software developer is responsible for fulfilling the promise to provide the licences to the customer. Usually, the reseller does not maintain an inventory of licences and cannot direct a licence to a customer other than the one who has entered the contract with the software developer. The reseller, therefore, has no inventory risk. However, the reseller generally has discretion to establish the price of the licence. Pricing discretion may be less relevant to the assessment of control if the reseller has limited flexibility in establishing the price.
In the case reviewed by ASIC the company did not have the control over the goods required by IFRS 15 and therefore could not recognise the revenue arising from the sale of the software. The revenue that should have been recognised by the company related only to the revenue it received for acting as agent.
Conclusion
Applying the principal versus agent guidance within IFRS 15 requires a detailed understanding of the underlying contracts and the exercise of significant judgement. LNP has assisted a number of our clients in assessing key accounting policies and in developing financial statement disclosures relating to judgements applied in the preparation of the financial statements.
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