Identifying principal-agent arrangements – the meaning of substance over form

The Accounting Standards Board is conducting its post-implementation review of GRAP 109 Accounting by Principals and Agents. ED 200 is available on the ASB website with a comment deadline of 15 September 2023.

GRAP 109 defines a principal-agent arrangement as follows:

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).

In assessing whether an arrangement meets the definition of a principal-agent arrangement, it is important to consider the economic substance of the arrangement over its legal form.

What is substance over form?

The Conceptual Framework for General Purpose Financial Reporting (Conceptual Framework) includes the qualitative characteristics which make information useful to users for accountability and decision-making. The qualitative characteristics include “faithful representation”, which means that information must be a faithful representation of the economic and other phenomena that it intends to represent.

The Conceptual Framework states that information that is a faithful representation illustrates the substance of the underlying transaction, other event, activity or circumstance, which is not necessarily the same as its legal form.

What does substance over form mean for principal-agent arrangements?

The concepts of principals and agents are described in law. As a result binding arrangements between principals and agents are often based on legal principles, rather than accounting principles.  

The principle of substance over form applies to GRAP 109 which means that entities should assess whether an arrangement is a principal-agent arrangement by analysing the substance, rather than the legal form.

For example, a binding arrangement may use terminology similar to GRAP 109 such as:

• “this arrangement is a principal-agent arrangement”;
• “party X is the principal” or “party Y is the agent”; and
• “party A undertakes activity Z on behalf of and for the benefit of party B”.

An entity does not conclude on the nature of an arrangement from an accounting perspective based on the legal form (e.g. the terminology used in the binding arrangement, or the legal interpretation or legal opinion on the nature of the arrangement). Instead, the entity assesses the substance of the arrangement by analysing the rights and obligations of the parties to the arrangement against the definition in GRAP 109. Only if the GRAP 109 definition is met is an arrangement a principal-agent arrangement for financial reporting purposes.

What is not substance over form?

For various reasons, entities may in practice act differently to the rights and obligations that are set out in a binding arrangement.

Applying substance over form does not mean that an entity may assess the way in which it operates in practice when that is different to the rights and obligations contained within a binding arrangement. Rather, substance over form means an entity assesses the rights and obligations in the binding arrangement and not the terminology used.

When the rights and obligations of a binding arrangement are unclear or unspecified, the parties to the arrangement should clarify the terms of the arrangement.

Comment to the Board on ED 200

The Board welcomes comment from all stakeholders on any aspect of GRAP 109.

Comment may be provided in writing through questionnaires (available on the ED 200 webpage on the ASB website) or in any other written form to info@asb.co.za. Comment may also be provided through roundtable discussions. 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.