Remarks before the 2017 AICPA Conference on Current SEC and PCAOB Developments
Barry Kanczuker, Associate Chief Accountant, Office of the Chief Accountant
Dec. 4, 2017
The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.
Good morning everyone. Today, I would like to discuss observations regarding principal versus agent considerations under Topic 606 and the classification of shipping and handling expenses for shipping and handling activities that are not a separate performance obligation under Topic 606.
Principal versus Agent Considerations
Some may be surprised that I am going to discuss Topic 606 principal versus agent considerations today. Others may be wondering what I did to get the opportunity to speak about this particular topic…perhaps I lost a bet. I can assure you that speaking about principal versus agent considerations is not the result of a lost bet. I chose to speak about this topic because determining whether an entity is a principal or an agent in a revenue transaction has been an area of frequent consultation with OCA under Topic 606, and OCA has concluded on fact patterns where the registrant was a principal and others where the registrant was an agent. Today, I would like to share observations from some of these consultations.
First, let me dispel a myth. I have been asked a number of times whether OCA has an internal model other than Topic 606 for assessing whether an entity is a principal or an agent. The answer to this question is no—OCA does not have an additional model to assess whether an entity is a principal or an agent in a revenue transaction. The accounting analysis that the staff considers follows the guidance prescribed in Topic 606.
I have observed that applying this guidance can be challenging in some fact patterns. I believe that some of the challenges are amplified in certain industries, such as the digital advertising industry or other industries in the technology space, where there are often multiple parties involved in providing the good or service, and transactions often take place within the blink of an eye.
Last year at this conference, Ruth Uejio made remarks that principal versus agent considerations in evolving business models may create “unique challenges that will require sound judgment.” I would like to continue this discussion. For example, I believe determining whether an entity controls a specified good or service immediately prior to the good or service being transferred to the customer may be especially challenging in certain types of service transactions, such as when enforceable contracts only exist among the parties once the service is being provided, or in transactions that take place in an instant. Topic 606 does provide indicators to support an entity’s assessment of whether it controls a specified good or service before it is transferred to the customer. However, these indicators of control should not be considered a checklist of criteria. The indicators may be more or less relevant to the assessment of control depending on the nature of the specified good or service and the terms and conditions of the contract. I believe that determining the relevance of an indicator to the assessment of control in certain types of transactions will require reasonable judgment.
As an example of the application of this guidance, I would like to share a recent pre-filing consultation that OCA received in the digital advertising space. In this consultation, the registrant’s customer, an advertiser, provided the registrant with specifications of the target audience it wished to reach through its digital advertising efforts. The advertiser’s specifications also included limited pricing information, such as the total advertising budget over a period of time. The registrant’s technology enabled it to identify and purchase advertising space that met the advertiser’s specifications on a real-time basis, as internet users in the advertiser’s target audience were browsing a website or viewing an app with available advertising space. The registrant had the ultimate discretion, including pricing discretion, for individual purchases of advertising space. The advertiser held the registrant responsible for reaching the advertiser’s target audience and otherwise meeting the advertiser’s specifications, and typically did not receive any information from the registrant that identified the specific websites or apps from which the registrant purchased the advertising space.
The registrant concluded that it was acting as a principal in the arrangement because it controlled the specified good or service before it was transferred to the customer. As part of its assessment of control, the registrant considered the indicators of control and noted that it was primarily responsible for fulfillment and had discretion in establishing the price. The staff views principal versus agent considerations to be an area that requires reasonable judgment—in this case, based on the facts and circumstances and the Topic 606 guidance, the staff did not object to the registrant’s conclusion that it was the principal in the transaction.
I want to be clear: an area of significant judgment does not mean that the standard permits optionality. In order to make these reasonable judgments, I believe that registrants need to “roll up their sleeves” to understand the nuances of the transactions and faithfully apply the Topic 606 model to their specific set of facts and circumstances.
Shipping and Handling Expenses
The staff has received questions under Topic 606 regarding the classification of shipping and handling expenses. Under Topic 606, if the shipping and handling activities are performed before the customer obtains control of the good, a registrant would account for the shipping and handling as activities to fulfill the promise to transfer the good. If shipping and handling is performed after a customer obtains control of the good, an entity may either account for shipping and handling as a promised service to the customer or elect to account for shipping and handling as activities to fulfill the promise to transfer the good. The questions we received related specifically to those shipping and handling expenses that were accounted for as activities to fulfill the promise to transfer the good, and these questions arose because the prior guidance on classification of shipping and handling expenses, and the explicit policy election regarding classification of such costs, was superseded by the new revenue standard, which now does not include any guidance that addresses the classification of shipping and handling expenses.
Given the noted absence of any guidance, I believe an entity will need to apply reasonable judgment in determining the appropriate classification of shipping and handling expenses for those shipping and handling activities that are accounted for as activities to fulfill the promise to transfer the good. Hence, the staff noted it would not object to the following approaches. First, the staff noted that it would not object to classification of these expenses within cost of sales. Second, given that there is no explicit guidance within Topic 606 related to the classification of shipping and handling expenses, the staff noted that it also would not object to an entity continuing to apply its previous policy regarding classification of these expenses, which could potentially be outside of cost of sales. I believe that a registrant that classifies significant shipping and handling costs outside of cost of sales should consider whether it should disclose the amount of such costs and the line item or items on the income statement that include them, similar to the disclosures required under the previous guidance.
Thank you for your time and attention.
 FASB Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (“Topic 606”).
 ASC 606-10-55-36A.
 Ruth Uejio, Professional Accounting Fellow, Office of the Chief Accountant, U.S. Securities and Exchange Commission, Remarks before the 2016 AICPA National Conference on Current SEC and PCAOB Developments (December 5, 2016), available at https://www.sec.gov/news/speech/uejio-2016-aicpa.html.
 BC16 of Accounting Standards Update (“ASU”) No. 2016-08, Revenue from Contracts with Customers (Topic 606) – Principal versus Agent Considerations (Reporting Revenue Gross versus Net).
 Paragraph 55-39A of ASC 606-10.
 ASC 606-10-25-18A.
 Paragraphs 25-18A and 25-18B of ASC 606-10.
 ASC 605-45-50-2.
 ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606).
 ASC 605-45-50-2 and ASC 605-45-S99-1.