GAAP Accounting for Pass-Through Expenses: ASC 606 Principal vs. Agent

Under GAAP, accounting for pass-through expenses turns on a single question: did you control the good or service before it reached the customer? If yes, you are the principal and record the full customer payment as revenue with the third-party cost as an expense. If no, you are the agent and record only the fee or margin you keep. ASC 606 provides the framework, and the answer determines whether your income statement shows gross revenue and matching costs or a clean net fee.

What Counts as a Pass-Through Expense

A pass-through expense arises when one company temporarily pays a cost that economically belongs to another party and then gets reimbursed. A marketing agency pays a media company for ad placements and bills the client. A staffing firm covers weekly payroll for temporary workers placed at a client site. A technology reseller purchases software licenses and delivers them to end users. Cash moves through the intermediary in each case, and the accounting question is whether that intermediary adds something of its own or acts as a conduit.

Getting the classification wrong inflates both sides of the income statement. A company that should report $2 million in net fees might instead report $10 million in gross revenue and $8 million in matching costs. Net income is unchanged, but every metric built on the top line — growth rate, gross margin percentage, revenue per employee — is distorted. Preventing that distortion is exactly what the principal-versus-agent framework in ASC 606 is designed to do.

The Control Test Under ASC 606

Control means the ability to direct the use of, and obtain substantially all the remaining benefits from, the good or service, including the ability to prevent someone else from doing so. ASU 2016-08, which clarified this part of ASC 606, identifies three specific scenarios in which an entity obtains that control before transferring it to a customer.¹

Acquiring then transferring. You obtain a good or asset from a third party and then transfer it to the customer. A distributor that buys inventory from a manufacturer before selling it to a retailer fits here.
Directing a service. You obtain the right to a service performed by a third party and direct that party to provide the service to your customer on your behalf. A general contractor that engages subcontractors but remains responsible for the finished project fits here.
Combining inputs. You obtain goods or services from third parties and combine them with your own to deliver something integrated. A technology firm that bundles third-party software with its own consulting and implementation services fits here.

If your role doesn’t fit one of these patterns, you are likely an agent. The evaluation is done separately for each distinct good or service in a contract, so you can be the principal for one deliverable and the agent for another within the same arrangement.

Three Indicators of Principal Status

When the control analysis isn’t conclusive from the scenarios alone, ASC 606 supplies three indicators that support a finding of principal status.¹

Responsibility for fulfillment. You are on the hook if the good or service doesn’t meet what the contract promises. You are the entity the customer looks to when something goes wrong, and you bear the risk that a third party’s work won’t be acceptable.
Inventory risk. You are exposed to loss if the good can’t be sold, becomes obsolete, or gets returned. This includes committing to purchase a good before any customer is identified. Simply agreeing to resell a specific volume does not by itself prove you controlled the goods.
Pricing discretion. You set the final price the customer pays. Agents typically earn a fixed fee or a percentage of a price set by someone else, so latitude to adjust the selling price suggests you control the economic upside.

No single indicator is decisive, and the standard does not weight any one indicator more heavily than the others. A company can have pricing discretion and still be an agent if it never controls the underlying good or service. The indicators support the control analysis; the control analysis governs the answer.

When Indicators Conflict

Conflicting indicators are where most companies struggle. A SaaS reseller might have pricing discretion (suggesting principal) but never take possession of the software and be unable to prevent the vendor from providing the service directly (suggesting agent). The resolution comes from returning to the fundamental question: did the entity control the specified good or service before it reached the customer? Whichever side has more evidence of directing use and capturing benefits before transfer determines the classification. Document the reasoning thoroughly, because auditors and regulators focus on the analysis, not just the conclusion.

Gross Method: Recording as a Principal

When you are the principal, you report the full consideration from the customer as revenue and the amount paid to the third party as cost of goods sold or an operating expense. Suppose you charge a client $50,000 for a project and pay a subcontractor $38,000. Your income statement shows $50,000 in revenue and $38,000 in cost of goods sold, yielding $12,000 in gross profit.

The entries are straightforward. When you pay the subcontractor, debit Cost of Goods Sold $38,000 and credit Cash $38,000. When the client pays, debit Cash $50,000 and credit Revenue $50,000. The $12,000 gross profit reflects your economic return.

Gross reporting produces a larger top line, but that carries consequences. Gross margin percentage drops because the actual margin is divided by a larger revenue base. Revenue per employee and price-to-sales ratios become less comparable against companies that act as agents in similar transactions. Debt covenants tied to revenue thresholds may be triggered earlier than they would under net reporting.

Net Method: Recording as an Agent

When you are the agent, you recognize only the fee or commission you earn. The pass-through amount and its reimbursement offset each other and never touch the revenue line. Using the same numbers, your income statement shows $12,000 in revenue and nothing in cost of goods sold for this transaction.

The entries route the pass-through through a clearing account. When you pay the third party, debit a Receivable (or Due from Client) account $38,000 and credit Cash $38,000. When the client pays, debit Cash $50,000, credit the Receivable $38,000, and credit Revenue $12,000. The pass-through cost never appears as revenue or expense.

Net reporting gives a cleaner picture of what the business actually earns, but the top-line number looks smaller. For early-stage companies trying to demonstrate scale, that can feel like a disadvantage. It reflects economic reality, and using the gross method when the facts support agent status creates real compliance risk.

Common Scenarios That Trip Companies Up

SaaS and Software Resale

A company that resells another vendor’s cloud software often concludes it is an agent. The reseller typically cannot modify the software, doesn’t provide the underlying service, and cannot prevent the vendor from delivering it. In many arrangements, the customer’s contract is ultimately with the software vendor, and the reseller’s role is to facilitate the sale and provide support. Unless the reseller integrates the software into a broader combined offering or takes on meaningful fulfillment risk, it generally reports only the margin or commission as revenue.

Integrated Services

The analysis shifts when an entity takes goods or services from multiple third parties and integrates them into something new. ASC 606 treats this as control: the integrating entity first obtains control of the inputs and then directs their use to create a combined output.¹ A consulting firm that hires subcontractors, purchases third-party data feeds, and combines everything into a custom analytics platform for a client is providing a significantly integrated service. That firm is the principal for the entire deliverable and reports the full contract value as revenue.

Reimbursed Travel and Out-of-Pocket Costs

Travel reimbursements are a frequent source of confusion. Under ASC 606, the answer follows the same control analysis. If you are the principal with respect to the travel (you booked the flights, chose the hotel, and bear the risk if the trip is wasted), the reimbursement is part of the transaction price and gets allocated across performance obligations. If you are merely passing through a cost the client directed, you are the agent for that specific expense and report it net.² Most professional service firms that incur travel on behalf of clients end up reporting these reimbursements gross because they control the travel arrangements, but the analysis is fact-specific.

Sales Tax Presentation

The principal-versus-agent analysis also affects sales taxes. ASC 606 includes a practical expedient at ASC 606-10-32-2A that lets entities elect, as an accounting policy, to exclude all sales and similar taxes collected from customers from the transaction price and present them net. The election is all-or-nothing across jurisdictions.

Companies that don’t elect the expedient must run a separate principal-versus-agent analysis for each tax jurisdiction. In jurisdictions where the company is legally obligated to pay the tax to the government, it is the principal in the tax transaction and presents the tax as part of gross revenue. In jurisdictions where the company merely collects on behalf of the government, it is the agent and presents the tax net. Most companies elect the expedient to avoid the jurisdiction-by-jurisdiction analysis.

Required Disclosures

Whether you report gross or net, ASC 606 requires disclosures that give financial statement users enough context to understand your role. Cover, at minimum:

Nature of the arrangement. A narrative explanation of which performance obligations involve acting as principal and which involve acting as agent. Agent disclosures should highlight that you are arranging for another party to transfer the goods or services.
Basis for the determination. The reasoning behind your principal-versus-agent conclusion for material transactions, including which control indicators you relied on.
Revenue disaggregation. Qualitative information about how customer type, geography, sales channel, and contract type affect the nature, timing, and uncertainty of revenue and cash flows.
Significant judgments. The methods, inputs, and assumptions used in areas requiring judgment, such as whether variable consideration should be constrained or how revenue was allocated across performance obligations.

Consistency across reporting periods matters as much as the initial classification. Changing your principal-versus-agent determination without a change in the underlying facts raises immediate red flags. If a genuine change occurs, such as a contract renegotiation that shifts fulfillment responsibility, the change and its financial impact should be explained in the footnotes.

What Happens If You Get It Wrong

Misclassifying pass-through revenue is not a minor bookkeeping issue. For public companies, a revision from gross to net (or vice versa) is treated as a correction of an error, not a simple reclassification. If material, it triggers a restatement of previously issued financial statements, which almost always damages investor confidence even when profitability is unchanged. A company shifting from gross to net reporting might see headline revenue drop by 70% or more without any change to the underlying business.

Regulatory consequences can follow as well. A company that overstates revenue by reporting gross when it should report net could cross the $1.235 billion annual gross revenue threshold for Emerging Growth Company status, losing access to the reduced reporting requirements available to smaller public companies.³

Non-GAAP Revenue and Pass-Through Costs

Some companies present non-GAAP revenue metrics that strip out pass-through costs or add them back. The SEC has been clear about the risks. Presenting a non-GAAP revenue figure that deducts transaction costs as if the company were an agent, when GAAP requires gross reporting as principal, is considered potentially misleading. The reverse is equally problematic.⁴

A supplemental revenue breakdown by product line calculated in accordance with GAAP is not a non-GAAP measure. Once you adjust those figures by netting out costs GAAP says should be gross, or grossing up fees GAAP says should be net, you have entered non-GAAP territory and triggered the SEC’s disclosure and reconciliation requirements.⁴

Documenting the Determination

The principal-versus-agent determination is one of the most scrutinized areas in a revenue recognition audit. Auditors expect the control analysis documented with references to specific contract terms, not a bare conclusion that the entity does or does not control the good or service. Strong documentation includes the contract language defining fulfillment responsibilities, evidence of which party bears inventory risk or nonperformance risk, pricing terms showing who sets the customer-facing price, and a written memo explaining how each indicator was weighed.

For entities that act as agents, the supporting evidence should show why the entity does not control the specified good or service. Useful sources include contract clauses that make the third-party vendor responsible for delivery and quality, terms showing the entity cannot modify or alter the good or service, and evidence that the customer’s primary relationship is with the underlying provider. The documentation burden grows when indicators conflict, because that’s where auditors spend the most time.

1
Financial Accounting Foundation. Proposed ASU – Revenue from Contracts with Customers (Topic 606) Principal versus Agent Considerations
2
FASB. PCC Meeting – Revenue Recognition Out of Pocket Expenses
3
U.S. Securities and Exchange Commission. Re: Staking Services Revenue Recognition Accounting Guidance
4
U.S. Securities and Exchange Commission. Non-GAAP Financial Measures