Do you know how to identify a principal-agent arrangement?

The Standard of GRAP on Accounting by Principals and Agents (GRAP 109) provides guidance on identifying principal-agent arrangements. Based on a need identified by stakeholders to review the Standard, the Board published the Invitation to Participate in the Post-implementation Review of GRAP 109 (ED 200) with a comment deadline of 15 September 2023.

What are principal-agent arrangements?

There are different definitions and interpretations of the arrangements that are “principal-agent” arrangements. These definitions and interpretations stem from various sources such as legislation, contracts and accounting and tax literature.

Entities that prepare financial statements using Standards of GRAP consider the definition in GRAP 109 to assess whether an arrangement is a principal-agent arrangement for financial reporting purposes by applying economic substance over legal form.

GRAP 109 defines principal-agent arrangements as:

A binding arrangement in which one entity (an agent), undertakes transactions with third parties on behalf, and for the benefit of, another entity (the principal).

Why is it difficult to identify a principal-agent arrangement?

The Board’s initial work to understand issues that exist with the application of GRAP 109 found that identifying whether an arrangement is a principal-agent arrangement is the most challenging step in practice to account for principal-agent arrangements.

There are different elements to the definition in GRAP 109 and an arrangement needs to meet all these elements. The Board found the following areas to be particularly difficult in practice. These will each be discussed in more detail in upcoming articles.

• Is an arrangement a binding arrangement?

GRAP 109 provides guidance on when an arrangement would be a binding arrangement, and how these arrangements could arise. A binding arrangement for purposes of GRAP 109 is, however, particularly difficult to identify when there are multiple arrangements that need to be read together. There may also be one arrangement that contains various rights and responsibilities related to principal-agent arrangements and other types of arrangements.

• Is an arrangement with third parties automatically a principal-agent arrangement?

The definition requires that third parties are involved, and the transactions with third parties are undertaken on behalf of and for the benefit of the principal. Entities may assume that all binding arrangements with three or more parties are principal-agent arrangements. However, in a principal-agent arrangement, the agent represents the principal and administers the transactions between the principal and the third parties according to the specific direction given by the principal.

• What is the nature of transactions with third parties in a principal-agent arrangement?

GRAP 109 explains that “transactions with third parties” includes the execution of a specific financial transaction with a third party as well as interactions with third parties where the agent represents the interest of the principal. The scope of the definition is often seen in practice as limited to financial transactions.

• How is substance over form applied to assess the definition?

Given the different definitions and interpretations of “principal-agent arrangements”, it is important to assess the economic substance of an arrangement when applying the definition of GRAP 109, irrespective of the legal form or legal interpretation of the arrangement.

Get involved in the review

The ASB invites all preparers, users and auditors of financial statements to participate in ED 200. Preparers are those responsible for preparing financial statements and those that prepare information used in the financial statements. Users of financial statements are service recipients, resource providers and their representatives. These users comprise lenders, creditors, donors and others that provide resources voluntarily, Parliament, legislatures, municipal councillors or other relevant authorities and taxpayers.

The Secretariat will obtain feedback from stakeholders through questionnaires (available on the ED 200 webpage on the ASB website), roundtable discussions and direct consultations. Contact elizna@asb.co.za to be invited to a roundtable discussion.

Disclaimer

The article has been prepared by the Secretariat of the ASB for information purposes only. It has not been reviewed, approved, or otherwise acted on by the Board.