Under ASC 606, reimbursed expenses are reported gross versus net based on whether your company is the principal or the agent for the underlying good or service. You report the full reimbursement as revenue (gross) when you control the good or service before transferring it to the customer. You report only your fee or margin as revenue (net) when you are merely arranging for a third party to provide it. The determination is made separately for each distinct performance obligation in a contract, and it can swing reported top-line revenue by millions without changing net income by a cent.
The Control Test Decides It
Control is the decisive factor. 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) If you obtain control of a third party’s service and then transfer it to the customer, you are the principal and report gross. If you are only arranging for the third party to deliver directly to the customer, you are the agent and report net.
For services, control often shows up as the ability to direct the third-party provider to perform on your behalf. A construction management firm that hires an electrician, assigns the scope, manages quality, and bears responsibility if something goes wrong has control of that electrical service before the customer receives the finished building. The firm is 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 manage and the agent for a government permit fee you simply prepay. The standard requires a separate assessment for each distinct performance obligation, not a blanket determination for the entire contract.
Four Indicators of Control
The standard provides indicators to evaluate control. No single indicator is automatically decisive, but together they build the case.1FASB. Revenue from Contracts with Customers (Topic 606)
Primary Responsibility for Fulfillment
If your company is on the hook for the acceptability of the good or service, meaning the customer looks to you rather than the third party when something goes wrong, that points toward principal status. A general contractor who guarantees the quality of a subcontractor’s plumbing work is primarily responsible. A law firm that submits a court filing fee on behalf of a client is not. The court is responsible for processing the filing, and the law firm has no control over that process.
Inventory Risk
Bearing the risk that goods become damaged, obsolete, or unrecoverable if the customer cancels signals principal status. A marketing agency that orders custom promotional materials before the client approves the final campaign owns those materials. If the client walks away, the agency is stuck with boxes of branded merchandise it cannot use elsewhere. By contrast, when an IT services firm prepays a cloud subscription that is immediately assigned to the customer’s account, there is nothing to become obsolete. The firm never truly held inventory.
Pricing Discretion
The ability to set the price the customer pays for the third-party good or service suggests you control it. A consulting firm that bills travel costs with a 15% administrative markup has pricing discretion that supports a principal conclusion for those travel expenses. If the contract requires billing the customer at exact cost with receipts attached, you are functioning as a payment conduit, which is a hallmark of an agent.
Contractual Liability to the Third Party
Who signed the contract with the supplier matters. If your company is the legal obligor, liable to pay the subcontractor regardless of whether the customer reimburses you, that indicates you obtained control of the service before passing it along. A general contractor who signs the subcontract and must pay the electrician even if the project owner disputes the invoice has taken on a risk that agents do not carry. When the contract makes clear that the customer is the ultimate obligor and your company simply processes the payment, you are acting as an intermediary.
How the Numbers Land
Once you have determined your role, the accounting follows directly. Take a contract where your company receives $100,000 from a customer and pays $90,000 to a third-party provider.
A principal records the full reimbursement as revenue and the underlying cost as an expense. The income statement shows $100,000 in revenue and $90,000 in cost of goods sold, producing $10,000 in gross profit and a 10% gross margin.
An agent records only the fee it retains. Revenue is $10,000. The $90,000 flows through as a liability offset, never touching the revenue line. Cost of goods sold is zero. Gross margin is 100%.
Net income is identical under both treatments at $10,000. But the optics change dramatically. 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 large pass-through costs — technology resellers, advertising agencies, staffing firms — the choice can double or halve reported revenue without changing actual profitability.
Why the Classification Reaches Beyond the Income Statement
Reported revenue drives more than appearances. Loan agreements often define financial ratios using revenue as a component. If a covenant requires maintaining a certain debt-to-revenue ratio or a minimum revenue threshold, gross reporting can make compliance look comfortable when the underlying economics have not changed. Lenders increasingly specify how revenue should be measured for covenant purposes, but older agreements may not account for the gross-vs-net distinction. A company that switches from gross to net reporting after an accounting review could find itself technically in default even though its actual cash flows are unchanged.
In states that impose gross receipts taxes, where the tax base is total revenue rather than net income, the distinction carries a direct cash cost. Companies reporting on a gross basis may owe tax on pass-through amounts they never economically earned. Specifics vary by state, and some jurisdictions allow exclusions for amounts received as an agent, but companies operating in these states need to coordinate their ASC 606 analysis with their state tax positions.
The SEC staff pays close attention to how companies present revenue, and the gross-vs-net question is a recurring focus in comment letters. Staff reviewers challenge registrants that appear to be inflating top-line revenue by reporting as a principal when the economic substance suggests agency.2SEC. Non-GAAP Financial Measures The SEC has specifically flagged situations where companies present non-GAAP revenue measures that strip out costs as if the company were an agent when GAAP requires gross reporting, and the reverse.
Common triggers for comment letters include sudden changes in the gross-vs-net classification without clear explanation, revenue growth driven primarily by increased pass-through costs rather than expanded operations, and inconsistent treatment of similar reimbursement arrangements across contracts or periods. Companies that receive a comment letter typically need to explain their control analysis in detail, walk through the indicators for specific contracts, and sometimes restate prior filings. The practical lesson: document the analysis thoroughly when you enter the contract, not when auditors or regulators ask about it later. A contemporaneous memo evaluating each control indicator for each category of reimbursable cost is far more persuasive than a retrospective justification assembled during an audit.
Common Industry Patterns
Certain industries encounter the reimbursement question more than others, and the answers tend to follow recognizable patterns. The analysis still depends on specific contract terms in every case.
Construction and engineering firms are frequently principals for subcontracted work. The general contractor selects subcontractors, manages quality, bears risk if work is defective, and is the legal obligor on subcontract agreements. Reimbursed subcontractor costs are typically reported gross. Permit fees and government filing costs that the contractor simply prepays on behalf of the owner are usually agent transactions reported net.
Professional services firms in consulting, accounting, and law face a split. Travel is the most common reimbursable cost, and the answer depends on how the contract is structured. A firm that books its own travel, selects hotels and airlines, and marks up the cost is more likely a principal. A firm that books travel at the client’s direction with no markup and passes through exact receipts looks more like an agent. Many firms in this space have concluded they are agents for travel reimbursements, but that conclusion requires support from the contract terms and actual practice.
Technology resellers and advertising agencies often have the most at stake. An advertising agency that buys media placements in its own name, negotiates rates, and marks up the cost to clients is typically the principal, and its reported revenue includes the full media spend. An agency that places ads through the client’s own accounts and merely collects a management fee is the agent. The difference can be tens of millions in reported revenue for the same underlying economic activity.
Drafting Contracts to Support the Conclusion
How you draft contracts shapes the outcome. If your intent is to act as an agent for certain reimbursable costs, the contract language needs to reflect that reality. Contract structures that reinforce agent status include arrangements where the customer makes all decisions about which provider to use, the provider is directly responsible to the customer for service quality, and your company has no obligation to find a replacement if the provider fails to perform.3FASB. Revenue Recognition Out of Pocket Expenses The employer-of-record arrangement is a useful illustration: when a staffing company places a professional but the client controls all hiring, firing, supervision, and compensation decisions, the staffing company is the agent despite technically employing the worker.
Contracts that point one direction while operating in a way that points the other are where companies get into trouble. If the contract says the customer selects the vendor, but in practice your project manager chooses every subcontractor and manages their output, auditors will look at the substance of the arrangement, not the contract labels.
What the Disclosures Need to Say
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 determination materially affects the financial statements, the disclosure should describe the reasoning: which control indicators were evaluated, what the entity concluded, and why. A company that concludes it is an agent for outsourced implementation services, for example, should explain that the third-party provider bears direct responsibility to the customer and the entity lacks pricing discretion over those services.
The nature of performance obligations also requires disclosure, including identifying obligations where the entity arranges for another party to deliver goods or services rather than delivering them itself. Without that disclosure, a reader comparing two companies in the same industry might mistake a net-reporting agent for a smaller business when it is actually handling the same volume as a gross-reporting competitor.
The standard does not set a specific dollar threshold for when these disclosures become mandatory; the general materiality framework applies. If the gross-vs-net determination changes reported revenue by an amount that could influence an investor’s decision, disclose it. Companies with material pass-through costs almost always need to address this in their revenue recognition policy notes.