• Stephan Lego-Deiber, Partner |

In my last article, I provided an overview of the requirements for determining whether an entity is acting as a principal or an agent. I want now to look at this topic in more detail, and with a focus on the real estate sector—where it can be a considerable challenge.

Rental contracts have a leasing component accounted for under IFRS 16 Leases, as well as (usually) a service component in scope of IFRS 15 Revenue Recognition. Like in previous years—under the old requirements—an entity must identify the particular components of the contract and determine which standard to apply. The usual approach is to apply IFRS 16 first, and then to treat any residual components of the contract with IFRS 15.

In this article, I will only look at the components which are in scope of IFRS 15. For issues around the accounting treatment under IFRS 16, please have a look at our other blog articles.

The nitty gritty

The principal-or-agent concept introduced by IFRS 15 differs, notably, in how it applies to the revenue that the landlord must recognize from operational services falling under IFRS 15.

Operational costs charged by landlords to tenants consist of several types, usually including services tenants can directly benefit from—like maintenance of the elevator—and those which they cannot—like insurance of the building. Following on from that, a clear distinction must be made between service and non-service components when it comes to the accounting treatment, as non-service components are considered part of the total consideration of the contract and must be allocated to all separately identified components (service and leasing components).

Once this is done, and if a third party is involved, any service in scope of IFRS 15 should be analyzed with regards to whether the entity controls the good or service before transferring it to the tenant as principals present revenue on a gross basis and agents on a net basis. This assessment must be made for each service separately, as the entity could be the principal for some of the services and the agent for others.

To accomplish this, as detailed in my previous article, the standard provides three indicators to assess if the landlord has control or not: primary responsibility for fulfilling the promise, inventory risk, and price discretion. However, you must understand the legal requirements for the country you are operating in.

The last point—price discretion—can be neglected in some jurisdictions where there is a regulation in place and landlords are not able to set individual prices. Additionally, in some countries landlords are primarily responsible for fulfilling the promise as required by law, and tenants are allowed to reduce the lease payments if the fulfillment is not considered satisfactory. Therefore, in order to assess those two indicators, the rights and obligations of landlords and tenants as per local laws and regulations must be understood as well.

With regards to inventory risk, it must be considered that this is not only applicable if a good is sold: in the real estate business the landlord has to bear a vacancy risk too, which is considered part of the inventory risk. This means that, in cases where an apartment is not rented, landlords are still required to pay for things like maintenance of the elevator or cleaning of the streets.

In conclusion

As you can see, the assessment for being a principal or an agent requires not only an understanding of the facts and circumstances of the contract, but also the legal requirements of your jurisdiction.

If you want to learn more about current hot IFRS topics, watch this blog and visit our IFRS website.