Government Contracts often include tasks requiring the Contractor to make purchases on behalf of the Government Customer. It’s important in these circumstances to consider whether the Contractor is, in reality, acting as an Agent. That conclusion might impact how the revenue for such activity is to be reported under U.S. GAAP – gross or net. For some contractors, this could impact their size standard classifications.
FASB ASC 605-45-45-1 to 19 “Reporting Revenue Gross as a Principal versus Net as an Agent” addresses whether a company should recognize revenue based on (a) the gross amount billed to a customer because it has earned revenue from the sale of goods or services or (b) the net amount retained because it has earned a commission or fee. Making this determination is a matter of judgment that depends on the relevant facts and circumstances. In assessing whether revenue relating to purchased materials should be reported gross or net, consider which party – the Contractor or the Customer is:
- Acting as the principal in the transaction
- Taking title to the products
- Establishing the price of the products
- Has discretion in supplier selection
- Makes determination of product specifications
- Has Credit Risk
- Has risks and rewards of ownership
Additionally, consider whether the compensation is based on a commission/fixed fee and whether the contractor is making changes to the product or performing part of the service/installation.
The following facts and circumstances would likely lead to reporting revenue related to materials purchases at net:
- Contractor is acting as the prime contractor.
- Purchase orders with suppliers include terms & conditions that reference the Prime Contract and push down the various applicable FAR clauses and establish supplier responsibility to meet government agency satisfaction.
- The specifications for the products are determined by the Customer.
- The suppliers/purchases are selected based on Customer procurement processes and must be pre-approved by the Contracting Officer or Contracting Officer’s Representative.
- The supplier establishes the price of the product.
- The supplier is responsible for quality assurance and warranties.
- Per terms & conditions, products are shipped F.O.B. delivery.
- Delivery is made directly to Customer who takes title to the products.
- No changes to the product or add any service is provided.
- The supplier bills Contractor (terms are net 60 days).
- Contractor invoices Customer for all costs, including their own material handling costs. There is no fee.
- Refusal to accept the invoice or product by Customer entitles Contractor to a refund from the supplier.
- Contractor never receives or takes title to the product.
Establishing the proper revenue recognition for material purchases which includes determining whether the Contractor is acting as an Agent requires a thoughtful review of the facts and circumstances. It can be especially important for Contractors considering business opportunities where potential material purchases, if recorded at gross, would substantially inflate revenues and expenses, reducing the Company’s gross margin. It might also impact the Contractor’s eligibility for future small business awards. In these circumstances, the Contractor may want to work with the Customer to structure the contract so that the Contractor is explicitly acting as an Agent only.
If a contractor is considering the applicability of gross versus net reporting they should also be considering the adequacy of their purchasing system (CPSR) under the DFARS criteria.