Under ASC 606, reimbursed expenses are reported gross (as revenue with a matching cost) when your company is the principal in the arrangement, and net (as a reduction of the amount owed to a third party, with only your fee hitting revenue) when your company is the agent. The dividing line is control: if you control the good or service before it reaches the customer, you’re the principal; if you’re arranging for someone else to provide it, you’re the agent. Same $100,000 reimbursement, same $10,000 profit, but the top line reads either $100,000 or $10,000 depending on which side of that line you land on.
The Control Test That Decides It
An entity controls a good or service when it can direct the use of that asset and obtain substantially all the remaining benefits from it.1FASB. Revenue from Contracts with Customers (Topic 606) For services, control often shows up as the ability to direct a third-party provider to perform on your behalf. A construction management firm that hires an electrician, sets the scope, manages quality, and stands behind the work has control of that electrical service before the customer receives the finished building. It’s the principal for that cost, even though the electrician did the physical work.
One contract can produce both conclusions. You might be the principal for subcontracted labor you actively manage and the agent for a government permit fee you simply prepay on the customer’s behalf. ASC 606 requires a separate assessment for each distinct performance obligation, not a blanket call for the whole contract.
Four Indicators of Principal or Agent Status
The standard lists indicators to help evaluate control. No single one settles the question, but together they build the case.1FASB. Revenue from Contracts with Customers (Topic 606)
Primary Responsibility for Fulfillment
If the customer looks to you when something goes wrong with the good or service, you’re likely the principal. A general contractor who guarantees the quality of a subcontractor’s plumbing work carries that responsibility. A law firm that submits a court filing fee for a client does not. The court is responsible for processing the filing, and the firm has no control over how that happens.
Inventory Risk
Bearing the risk that goods become damaged, obsolete, or unrecoverable if the customer cancels points to principal status. A marketing agency that orders custom promotional materials before the client signs off on the final campaign owns those materials. If the client walks, the agency is stuck with boxes of branded merchandise it can’t resell. Contrast that with an IT services firm that prepays a cloud subscription assigned immediately to the customer’s account. Nothing sits on the shelf. The firm never really held inventory.
Pricing Discretion
Setting the price the customer pays for the third-party good or service suggests you control it. A consulting firm that bills travel with a 15% administrative markup has pricing discretion, which supports a principal conclusion for those travel costs. When the contract requires billing the customer at exact cost with receipts attached, you’re a payment conduit, and that’s the shape of an agent.
Contractual Liability to the Third Party
Who signed the contract with the supplier matters. If your company is legally on the hook to pay the subcontractor whether or not the customer reimburses you, you obtained control of the service before passing it along. A general contractor who signs the subcontract has to pay the electrician even if the project owner disputes the invoice. Agents don’t carry that risk. When the customer is the ultimate obligor and your company only processes payment, you’re an intermediary.
What Gross and Net Reporting Look Like on the Statements
Once you’ve settled the role, the mechanics follow directly.
Principal: Gross
The full reimbursement is revenue and the underlying cost is an expense. Receive $100,000 from a customer, pay $90,000 to a subcontractor, and the income statement shows $100,000 in revenue, $90,000 in cost of goods sold, and $10,000 of gross profit. Gross margin is 10%.
Agent: Net
Only the fee or commission you keep is revenue. Same $100,000 in, same $90,000 out, and you recognize $10,000 in revenue for arranging the service. The $90,000 flows through as a liability offset and never touches the revenue line. Cost of goods sold is zero. Gross margin is 100%.
Why It Matters Even Though Net Income Is the Same
Net income is $10,000 either way. The optics are not. The principal looks like a $100,000 business with thin margins. The agent looks like a $10,000 business with perfect margins. For companies with heavy pass-through costs — technology resellers, advertising agencies, staffing firms — the choice can double or halve reported revenue without changing what the business actually earns. Revenue growth rates, gross margin percentages, and revenue-per-employee ratios all shift on a judgment call.
Debt covenants compound the exposure. Loan agreements often use revenue in their financial ratios. A covenant that requires a certain debt-to-revenue ratio or a minimum revenue floor can look comfortable under gross reporting and tight under net, even though cash flows haven’t moved. Lenders increasingly specify how revenue should be measured for covenant purposes, but older agreements may not. A company that switches from gross to net after an accounting review can find itself technically in default with unchanged economics.
In states that impose gross receipts taxes, where the tax base is total revenue rather than net income, the distinction has a direct cash cost. Gross reporting can create tax liability on pass-through amounts you never economically earned. Rules vary by state, and some allow exclusions for amounts received as an agent, so the ASC 606 conclusion needs to be coordinated with the state tax position.
How Common Industries Tend to Land
The analysis always turns on specific contract terms, but certain patterns recur.
Construction and engineering firms are usually principals for subcontracted work. The general contractor selects the sub, manages quality, bears risk on defects, and is the legal obligor. Reimbursed subcontractor costs are typically gross. Permit fees and government filings that the contractor merely prepays for the owner are usually agent transactions reported net.
Professional services firms — consulting, accounting, law — split on travel. A firm that books its own travel, chooses hotels and airlines, and marks up the cost tends to be a principal. A firm that books at the client’s direction with no markup and passes through exact receipts looks like an agent. Many firms in this space have landed on agent treatment for travel, but the contract terms and the actual practice need to support it.
Technology resellers and advertising agencies have the most at stake. An advertising agency that buys media placements in its own name, negotiates rates, and marks up cost to clients is typically the principal, and reported revenue includes the full media spend. An agency that places ads through the client’s own accounts and collects a management fee is the agent. Tens of millions in reported revenue can turn on that call for the same underlying activity.
Software companies offering implementation services alongside a SaaS product have an extra step. If implementation labor from a third-party contractor isn’t a distinct performance obligation on its own, it gets bundled with the software, and the principal-vs-agent analysis applies to the combined obligation rather than the implementation service in isolation.2FASB. Revenue Recognition Out of Pocket Expenses
Drafting Contracts That Support Your Conclusion
Contract language shapes the outcome, but only when the language matches reality. Arrangements where the customer engages the third-party provider separately and your company only facilitates payment support agent treatment. Arrangements where the customer has no direct relationship with the third party, you select and manage the provider, and quality falls on your shoulders support principal treatment.
Structures that reinforce agent status include the customer choosing which provider to use, the provider being directly responsible to the customer for service quality, and your company having no obligation to find a replacement if the provider fails to perform.2FASB. Revenue Recognition Out of Pocket Expenses An employer-of-record arrangement illustrates the pattern: when a staffing company places a professional but the client controls hiring, firing, supervision, and compensation, the staffing company is the agent despite technically employing the worker.
Trouble comes when the contract points one direction and operations point the other. If the contract says the customer selects the vendor, but in practice your project manager picks every subcontractor and manages their output, auditors will follow the substance and ignore the labels.
Disclosures and SEC Exposure
ASC 606 requires enough disclosure for a reader to understand the nature, amount, timing, and uncertainty of revenue from customer contracts.1FASB. Revenue from Contracts with Customers (Topic 606) When the principal-vs-agent call materially affects the financial statements, the disclosure should walk through the significant judgments: which control indicators were evaluated, what you concluded, and why. A company that treats outsourced implementation services as an agent, for example, should explain that the third-party provider bears direct responsibility to the customer and that the company lacks pricing discretion.
Disclosure of performance obligations should also identify obligations where the entity arranges for another party to deliver rather than delivering itself. Without that context, an investor comparing two companies in the same industry might mistake a net-reporting agent for a smaller business when it’s actually moving the same volume as a gross-reporting competitor.
There is no specific dollar threshold that triggers these disclosures — general materiality governs. If the gross-vs-net call changes reported revenue by an amount that could influence an investor’s decision, disclose it. In practice, companies with material pass-through costs almost always need to cover this in their revenue recognition policy notes.
The SEC staff watches this area closely. Reviewers challenge registrants that appear to inflate top-line revenue by reporting as a principal when the economic substance points to agency, and the staff has specifically flagged non-GAAP revenue measures that strip out costs as if the company were an agent when GAAP requires gross, or the reverse.3SEC. Non-GAAP Financial Measures Common comment-letter triggers include sudden changes in classification without clear explanation, revenue growth driven mainly by rising pass-through costs, and inconsistent treatment of similar reimbursement arrangements across contracts or periods. Registrants that draw a comment letter typically have to explain the control analysis in detail for specific contracts, and sometimes restate.
Document the analysis at the time you sign the contract, not when auditors ask later. A contemporaneous memo evaluating each control indicator for each category of reimbursable cost holds up far better than a justification assembled during an audit. For companies with significant pass-through costs, the review belongs in the contract intake process, not in the year-end close.