How do you determine whether a company should report revenue gross (as principal) or net (as agent)?
Waypoint Commerce operates an online marketplace where third-party vendors sell electronics. Waypoint collects payment from customers, takes a 15% commission, and remits the rest to vendors. The customer price for a laptop is $1,000. Should Waypoint report $1,000 or $150 as revenue? My CFA Level II materials mention 'control' as the key determinant but I'm not sure how to apply it.
Principal vs. agent is a perennial exam topic because it dramatically affects revenue (and thus ratios) without changing net income. The determining factor is control.
The Control Test (IFRS 15 / ASC 606)
A company is the principal if it controls the good or service before it is transferred to the customer. Control indicators include:
- Primary responsibility for fulfilling the promise to the customer
- Inventory risk — bearing the risk of loss or return before or after transfer
- Pricing discretion — the ability to set the price the customer pays
If the company does NOT control the good/service, it is an agent and reports revenue net (commission only).
Waypoint Commerce Analysis
| Indicator | Assessment | Points To |
|---|---|---|
| Primary responsibility | Vendors handle shipping and warranties; Waypoint only processes payment | Agent |
| Inventory risk | Waypoint never takes title to inventory; vendor ships directly | Agent |
| Pricing discretion | Vendors set their own prices; Waypoint cannot change them | Agent |
Conclusion: Waypoint is an agent.
Revenue Reporting:
| Method | Revenue | COGS | Gross Profit | Net Income |
|---|---|---|---|---|
| Gross (Principal) | $1,000 | $850 | $150 | $150 |
| Net (Agent) | $150 | $0 | $150 | $150 |
Notice: Net income is identical. But look at the ratios:
| Ratio | Gross | Net |
|---|---|---|
| Revenue | $1,000 | $150 |
| Gross margin | 15% | 100% |
| Revenue growth (if volume doubles) | +100% | +100% |
| Revenue per employee | Much higher | Much lower |
Analyst Implications
- Compare companies consistently — if analyzing Waypoint vs. a competitor that reports gross, adjust one to match the other before comparing revenue growth or margins
- Revenue-based multiples change dramatically — EV/Revenue for a gross reporter looks much cheaper than for a net reporter, even if they are economically identical
- Watch for classification changes — some companies switch from gross to net (or vice versa) which creates artificial revenue growth or decline
Exam tip: The exam often presents a scenario and asks you to determine principal vs. agent. Focus on the three control indicators, especially inventory risk. If the company never takes title or bears loss risk, it is almost certainly an agent.
Practice revenue recognition problems in our CFA Level II question bank.
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