Principal/Agent Considerations (Gross vs Net) in ASC 606

McDonald’s (the Company) establishes cooperatives to facilitate advertising services for Company-operated and franchised restaurants, as well as contracting with third-party marketing agencies. These services are outlined in a marketing plan voted on by members of the cooperative annually, and McDonald’s facilitates the billing and collection under such plan.

Under the Company’s franchise agreement, a franchisee is required to pay an initial fee for the right to operate a McDonald’s restaurant, a royalty for brand support, and rent for continued use of the real estate. The franchise agreement also obligates the franchisee to advertise the restaurant to the public based on a percentage of gross sales each year. However, the franchise agreement does not include an obligation by the Company to provide advertising services. Therefore, any advertising services performed by a third-party agency are separate contracts with distinct services offered to the restaurants, even if McDonald’s is the contracting party.

In response to an SEC comment letter, the Company considered the indicators for control outlined in ASC 606-10-55-39, and included how each point may be applicable to McDonald’s:

1. The entity is primarily responsible for fulfilling the promise to provide the specified good or service.
   • McDonald’s is not primarily responsible for providing advertising or marketing activities to restaurants. A third-party advertising or marketing agency selected to execute a marketing campaign is responsible for fulfilling the contract for these services. Notably, the operating and governance model of the cooperative does not allow McDonald’s to unilaterally approve or make changes to the annual marketing plan and its campaigns therein.
2. The entity has inventory risk before the specified good or service has been transferred to a customer or after transfer of control to the customer.
   • Inventory risk does not apply in McDonald’s cooperative arrangements, as the arrangement is to facilitate the delivery of advertising and marketing services, not a product or good that would be considered subject to inventory risk.
3. The entity has discretion in establishing the price for the specified good or service.
   • Through the voting structure of the cooperative described above, McDonald’s does not have the ability to control the annual contribution rate that restaurants pay to the cooperative each year. McDonald’s also does not have the discretion to set the price that the cooperative pays for the advertising services, as that is dictated by the independent agencies providing the services.

Based on these factors, McDonald’s determined that it acts as an agent for the advertising services managed through cooperative arrangements, rather than a principal (June 2020 letter to the SEC).

Kontoor Brands (Kontoor) is a global lifestyle apparel company with a portfolio of consumer brands such as Lee, Wrangler, and Rock & Republic. Under a typical concession arrangement, Kontoor maintains a dedicated sales area within its retail locations to use the space in exchange for payment of a concession fee. In a letter dated April 29, 2021, the SEC sent Kontoor the following request:

Please tell us if you recognize concession sales on a gross or net basis and explain how you assessed the guidance in ASC 606-10-55-36 through -40 in determining the appropriate accounting treatment and your role as principal or agent.

In its response, Kontoor highlighted that since it “owns the brand, designs and manufactures the product, selects each concession location as part of its overall retail strategy, determines the product assortment to be offered in each concession location, and manages the brand image,” it is primarily responsible for providing the specified goods to the customer. The concessionaire is simply “a party acting on the Company’s behalf to facilitate the final sale to the end consumer.”

Kontoor also owns all the inventory and retains inventory risk until the merchandise is sold. Since Kontoor is also obligated to accept any product returns, it is exposed to risk for any unsold products at the end of a season. While the “concessionaire has physical possession of the product…it is holding the inventory in custody for the Company until the time of sale to the end consumer.” Therefore, Kontoor retains all inventory risk before and after transferring control to the end consumer.

Lastly, Kontoor and its concessionaires have discussions to determine the product’s pricing, especially during seasonal sales. Thus, it has a significant influence in determining prices for the products sold to the end consumer.

Based on these factors, Kontoor determined that it is the principal in its concession sales and thus qualifies for gross reporting according to ASC 606-10-55-36 through 40 (May 2021 letter to the SEC).

Bsquare is a software company that helps other companies get their products to market quickly. Bsquare helps companies build and operate intelligent devices and systems in which they operate. These systems are cloud-enabled, contribute data, facilitate distributed control and decision making, and operate securely 24/7. In a letter dated July 26, 2023, the SEC sent BSQUARE the following request.

“You disclose you exercise judgment in certain transactions when determining whether you should recognize revenue based on the gross amount billed to a customer (as a principal) or the net amount retained (as an agent)….Please disclose here the factors you consider in exercising judgment in determining whether you are the principal or agent.”

In its response, BSQUARE highlights that more than 95% of their revenue is recognized on a gross basis (as a Principal), however there are a few transactions with which they recognize revenue on a net basis (as an Agent). Selling COA’s make up the vast majority of their Partner Solutions segment revenue. BSQUARE cites ASC 606-10-55-39 as their basis of conclusion on whether they control these COAs that they sell to customers.

BSQUARE responds in this manner to the inquiry. By demonstrating their level of control as defined in ASC 606-10-55-39. 1) BSQUARE CORP has the sole responsibility for fulfilling these orders. The company is in charge of shipping the licenses. 2) The company has inventory risk. If the customer is not happy with the licenses, they return those licenses to BSQUARE. 3) The company is in charge of setting the prices for the COAs. They are the only ones who are in charge of influencing or setting this price.

BSQUARE shows that they fulfill all three criteria for control. This is how they argue that they are making the correct judgment that they should act as a Principal in these transactions.

Echo Global Logistics (Echo) provides transportation and supply chain services to its customers by connecting businesses with carriers that can transport goods. To provide this service, Echo uses its network of truckload contract carriers, rail providers, and international air and ocean carriers. Echo considers itself the principal in these transactions. In a letter dated July 11, 2019, the SEC sent Echo the following request:

Please provide us with your analysis regarding how you determined gross reporting for your transactional revenue was appropriate pursuant to ASC 606-10-25-25 and 606-10-55-36 through 40. Specifically address how you considered the definition of control and how you are directing any third-party providers.

In its response, Echo identified the services it provides to its transactional clients as brokerage and transportation management services. These services include “scheduling delivery, tracking the freight, notification of any in-transit updates, delivery of the freight and, if required, claims management for damaged goods.” Echo sets prices for the customer and retains the right to direct carriers to perform the intended services. Echo has ongoing communication with and control over the actions of the third-party carriers. Echo is responsible for resolving customer claims.

In addition, Echo has some inventory risks. Echo doesn’t contract with third-party carriers until it has a customer contract for a specific shipment, but once a contract with a third-party carrier has been established, Echo must pay the carrier even if it doesn’t receive payment from the customer. Echo may also have to pay a fee to the carrier if the customer cancels their shipment.

Based on these factors, Echo determined that it does have control over the brokerage and transportation management services before they are transferred to the customer, which makes Echo the principal in the transaction (July 2019 letter to the SEC).

RVL Pharmaceuticals PLC (RVL) is a pharmaceutical company that specializes in the commercialization and development of eye care and medical aesthetics products. In July of 2023, RVL responded to the following SEC inquiry regarding their principal/agent considerations. “Tell us who has primary responsibility for fulfilling the order and why. Refer to ASC 606-10-55-39a.

Tell us if Eversana has inventory risk before the product is transferred to the end customer practitioner. Refer to ASC 606-10-55-39b.”

RVL concluded that they are the principal in the transactions in question based on their retention of control over the product prior to its transfer to the end customer. Their justification of their position is provided as follows.

“The Company consistently exhibits its control over the product during the Direct Dispense lifecycle, including when the product resides in Eversana’s custody during their delivery of channel management services, and also when the product resides in the custody of the third-party shipping intermediary during the product delivery. Only the Company determines to whom the product is sold and at what price. The Company obtains the product order from the practitioner, conveys the product order details to Eversana, determines the third-party shipping intermediary to fulfil the product shipment, and directs Eversana to provide the channel management services on its behalf. Further, the end customer practitioner interacts solely with the Company and pays only the Company directly for the purchase of the product.”

This response demonstrates that the ultimate decision of control is based upon the basic guidelines set forth in ASC 606-10-25-25. The individual elements of control discussed in the quotation above are great examples of how elements of control can be analyzed in different situations. RVL provides supplemental evidence based upon ASC 606-10-25-39 to further defend their position.