Question

Principal vs. agent (LO 3-5) Online Auction Company (OAC) provides a platform for its users to buy and sell goods. Sellers post goods for sale and other users bid on them. They high bidder wins the auction and purchases the goods. After each auction, the seller pays OAC a 10% fee and the buyer pays OAC a 5% fee. For example, if an auction closes with a high bid of $100, the buyer remits $105 (the winning bid of $100 plus the 5% buyer’s fee) and OAC pays $90 to the seller (the winning bid of $100 less the 10% seller’s fee). In 2019, customers completed auctions on OAC having an aggregate selling price of $100 million, and OAC had operating costs of $2 million. It prepared the following partial income statement (through operating income) for 2019. ($ in millions) Contract price $ 100 Buyer fees   5 Total revenue 105 Cost of goods sold   90 Gross profit 15 Operating expenses   2 Operating income $  13 Required: Prepare a revised partial income statement that is consistent with ASC Topic 606 on revenue recognition. Suppose OAC changes its user agreement so that when an auction ends, the seller is not charged a commission. Instead, the seller agrees to sell the auctioned item to OAC for 90% of the winning bid amount, and OAC immediately resells it to the high bidder at the page 158winning bid amount. OAC collects the winning bid amount and remits 90% of it to the seller, as before. Then the seller delivers the auctioned goods to the winning bidder on behalf of OAC. In this case, would the proper income statement be the original one provided or the revised one from requirement 1?

Answer 1

ASC 606 - Revenue From Contract With Customers explains how the revenue should be recognized.

The question is asked for Principal versus agent relationship and how revenue should be recognized gross or net.

Revenue Can be recognized in two ways as under -

Particulars	Gross presentation	Net Presentation
Contract Price	100	-
Commission from Seller	-	10
Buyer Fees	5	5
Cost of Goods sold	(90)	-
Operating Expenses	(2)	(2)
Operating income	13	13

As you can see from both of the above methods the Operating income will remain same but the presentation part is different.

Gross presentation can be followed when the goods or services are provided by the company as principal. A Company is principal if it controls the goods before the same are transferred to the customer. So if there is no control then the company is agent and it has to do net presentation.

That means ASC 606 clearly states that Control of goods or services is the deciding factor for the gross or net presentation.

Step 5 of the standard explains the situation how to recognize the revenue and also defines control

Control is defined as ability to direct the issue of goods and obtain substantially all the remaining benefits from those goods.

The benefit means right to decide and gain from potential cash flows from the goods in future by selling, pledging or holding the goods.

From the Above it is clear that the Online Auction Company (OAC) has made wrong presentation. It should have shown the net presentation as it do not hold the control over goods. The revised presentation is given Above in the table.

The Second Question asks about if the agreement terms changed will the original gross presentation sustain?

As per 606 the Answer is NO. The Net presentation is to be done even if the agreement terms changed because as per new agreement terms as well the goods are sold at 90 % Value to OAC on paper but seller delivers the auctioned goods to the winning bidder on behalf of OAC. that means the control of the goods is with Seller and it never comes to OAC. Just on paper the transaction are done for sale and purchase instead of earlier transaction.

Thus, even if the agreement terms changed the Presentation of revenue recognition will not change, it will be shown at net basis.