ASC 606: Are Reimbursed Expenses Revenue?

The Financial Accounting Standards Board’s (FASB) ASC 606, Revenue from Contracts with Customers, provides the framework for recognizing revenue. Under this standard, accounting for reimbursed expenses requires careful analysis. These are out-of-pocket costs, such as shipping, travel, or third-party fees, that a company incurs and then bills to its customer. Whether these reimbursements are treated as revenue depends on the company’s role in the transaction. Companies must determine if they are providing the underlying good or service themselves or simply arranging for another party to provide it.

The Principal Versus Agent Consideration

ASC 606 requires a company to determine if it is acting as a “principal” or an “agent” when a third party is involved in providing goods or services to a customer. This assessment determines the proper accounting for reimbursed expenses and the amount of revenue a company reports.

A company is a principal if it controls the specified good or service before it is transferred to the customer. The company’s performance obligation is to provide the good or service itself, and it recognizes revenue on a gross basis. For example, if a consulting firm hires a subcontractor but integrates their work into a final deliverable, it likely controls the service and acts as a principal.

Conversely, a company is an agent if its role is to arrange for another party to provide the good or service. An agent does not control the good or service, and its performance obligation is to facilitate the transaction. In this scenario, the reimbursed expense is not revenue but the settling of a liability incurred for the customer, and revenue is recognized on a net basis as the fee or commission earned.

The analysis must be performed for each distinct good or service promised to the customer. A company could be a principal for some parts of a contract and an agent for others. This evaluation requires judgment and a thorough understanding of the contractual terms and the relationship between all parties.

Indicators for Determining Control

The determination of principal or agent rests on the concept of control. Control is the ability to direct the use of, and obtain substantially all of the remaining benefits from, a good or service before it is transferred to the customer. ASC 606 provides several indicators to assess control, though no single indicator is determinative.

One indicator is which party holds the main responsibility for fulfilling the promise to the customer. This includes being responsible for the acceptability of the good or service. If a customer’s primary point of recourse for a faulty product or poor service is your company, it suggests you are acting as the principal.

Another indicator is inventory risk. A company that bears inventory risk before the good is transferred, or after transfer through a right of return, is likely a principal. For services, this might manifest as the risk of having to re-perform the service at the company’s own cost if it is not satisfactory.

The entity’s discretion in establishing the price for the good or service is also a factor. If a company has the freedom to set the price the customer pays, it points toward being a principal. An agent, on the other hand, has little to no latitude in setting the final price and their compensation is usually a fixed fee or percentage.

Accounting and Reporting Treatment

Once the principal versus agent determination is made, the accounting treatment dictates whether revenue is recognized on a gross or net basis. While the total revenue reported will differ, the net income impact is often the same under both methods.

If a company is a principal, it uses the gross method. The total amount billed to the customer, including the reimbursed expense, is recorded as revenue. The cost paid to the third party is then recorded as an expense, such as cost of services. For example, if a company bills a client $5,000 for a service that included a $1,000 third-party fee, it would record $5,000 in revenue and $1,000 in cost of services.

If a company is an agent, it uses the net method. The reimbursement from the customer is not revenue. The amount paid to the third party and the corresponding reimbursement from the customer are recorded on the balance sheet. The only amount recognized as revenue is the fee or commission earned for arranging the transaction. For instance, if a company pays a $500 fee for a customer and bills for that amount plus a $50 service fee, only the $50 is recognized as revenue.

Practical Application Examples

Consider a scenario involving shipping costs. A manufacturer sells goods and arranges for a third-party carrier to deliver them. If the manufacturer is responsible for the goods arriving undamaged, handles delivery complaints, and has discretion in selecting the carrier, it is likely a principal. The manufacturer would record the full amount billed for shipping as revenue and the actual cost paid to the carrier as a cost of goods sold.

In another example, an advertising agency might purchase ad space for a client. If the agency acquires the space as directed by the client from a specific vendor at a specific price, and the client is responsible for the ad’s performance, the agency is likely an agent. The reimbursement for the ad space would not be revenue; only the agency’s commission or fee would be.

Reimbursed travel costs for a consulting engagement also require analysis. If a consulting firm’s contract stipulates reimbursement for travel expenses, the determination depends on control. If the firm is responsible for the overall consulting service and travel is an integral part, the firm may be the principal. However, if the client directs travel choices and bears the associated risk, the firm might be an agent for that component of the service.