Distributors: principal or agent

Why do distributors raise principal or agent questions?

A distributor sits between the manufacturer and the shops that sell to consumers. If it buys the goods and resells them on its own account, it is the manufacturer's customer, and each party recognises revenue on its own sale. If it only holds and delivers the manufacturer's stock and collects cash on its behalf, it is an agent: the shops are the manufacturer's customers, and the distributor earns a fee. Many contracts sit in between, with the manufacturer setting resale prices, funding promotions and taking back old stock, so the answer depends on the detail. See FMCG accounting.

Is the distributor the manufacturer's customer?

Under IFRS 15, the manufacturer recognises revenue when the distributor obtains control of the goods, meaning it can direct their use and obtain substantially all their remaining benefits. Indicators include a present obligation to pay, legal title, physical possession, the risks and rewards of ownership, and acceptance. Signs that the goods are instead on consignment include:

• the manufacturer controls the goods until a specified event, such as the sale to a shop;
• the manufacturer can require the goods to be returned or sent to another distributor; and
• the distributor has no unconditional obligation to pay for the goods, although it may have paid a deposit.

Who sets the price to shops, who bears the cost of expired or damaged stock, and who carries the risk that shops do not pay are also important evidence. See consignment and bill-and-hold.

Principal or agent: one distributor, two contracts

A manufacturer's goods are sold to shops for US$ 1,000 thousand in a year. Under the first contract, the distributor buys the goods at a 10% discount to the shop price, 900 thousand, takes title on delivery, sets its own prices to shops, carries the stock until it is sold and bears the risk that shops do not pay. Under the second contract, the manufacturer keeps title until the goods reach the shops, sets the prices, takes back expired stock and bears the credit risk, and the distributor earns a commission of 6% of sales, 60 thousand, for storing, delivering and collecting.

Under the first contract, the distributor is the manufacturer's customer and a principal in its own sales: the manufacturer recognises revenue of 900 thousand when it delivers to the distributor, and the distributor recognises 1,000 thousand of revenue with 900 thousand of cost of sales. Under the second, the shops are the manufacturer's customers: it recognises 1,000 thousand of revenue as the goods are delivered to the shops and treats the 60 thousand commission as a selling and distribution cost, not a reduction of revenue, because the distributor is not its customer. The distributor recognises only its 60 thousand commission. Total profit in the chain is similar, but revenue, margins and working capital look very different.

How does a distributor decide whether it is a principal or an agent?

A distributor is a principal if it controls the goods before they are transferred to the shops. IFRS 15 gives three indicators: it is primarily responsible to the shop for supplying the goods, it bears inventory risk before the goods are sold or after they are returned, and it has discretion in setting the price. No single indicator decides the question, and the assessment is made for each type of product it sells. A distributor that buys stock, holds it at its own risk and negotiates its own prices is a principal; one that never takes title and passes on prices set by the manufacturer is usually an agent. See principal versus agent.

How are payments to distributors treated?

If the distributor is the manufacturer's customer, payments to it are consideration payable to a customer and reduce revenue, unless they pay for a distinct service at fair value. This covers target incentives, support for stock the distributor holds, and claims for promotions the distributor runs with shops on the manufacturer's behalf, which are consideration payable to the customer's customers. Payments for a distinct service, such as merchandising that the manufacturer could buy from a specialist agency, may be an expense, but only up to the service's fair value. If the distributor is an agent, its fees are a cost of selling. See trade promotion spending.

What about loading stock into distributors before a period end?

Shipping unusually large quantities to distributors just before a reporting date, often with extended credit, generous return rights or promises of extra support, is known as channel stuffing. It brings forward revenue that belongs to later periods. Under IFRS 15, the return rights and support are variable consideration, and the constraint may limit revenue; if the distributor is not really obliged to pay until it sells the goods, control may not have passed at all. Auditors look at distributors' stock levels, credit notes issued after the period end and unusual terms on late shipments. See returns and markdown allowances.

How does US GAAP differ?

ASC 606 uses the same control model and the same principal or agent indicators. Before ASC 606, some US companies deferred revenue until distributors sold the goods on, where the final price was not fixed because of price protection and return rights. ASC 606 replaced that approach: revenue is now generally recognised when control passes to the distributor, with the variable consideration estimated and constrained. See ASC 606 principal versus agent.

This guide is general information. It is not tax or legal advice for your situation.