When is an arrangement a principal-agent arrangement (Part 2)?

A common misconception is that any transaction with more than two parties is a principal-agent arrangement. This is not the case. A principal-agent arrangement is a binding arrangement where one entity (the agent) represents the interests of another entity (the principal) when that entity (the principal) transacts with third parties.

To understand when GRAP 109 should be applied, these two steps should be applied.

Step 1 – Is there a binding arrangement?

The first step in assessing whether an entity is a party to a principal-agent arrangement is to assess whether a binding arrangement exists.

A binding arrangement (for purposes of GRAP 109) is any arrangement that confers enforceable rights and obligations on parties to the arrangement. These rights and obligations could arise from:

• contracts;
• legislation or similar means; and/or
• common law.

Some arrangements may be governed by both legislation (which sets the overarching framework within which certain transactions occur) and contracts (which set out the specific details of an arrangement between the parties, e.g. the activities to be undertaken, re-imbursement of costs, fees, service standards etc.). Both should be considered in deciding the nature of the arrangement and what rights and obligations exist for the parties.

If there is no binding arrangement that refers to one entity (agent) undertaking transactions with third parties on behalf of another entity (principal), then GRAP 109 should not be applied.

Step 2 – Understanding the roles of the parties to the arrangement

The second step is assessing whether one entity (the agent) represents the interests of another entity (the principal) when that entity (the principal) transacts with third parties.

Representing the interests of another entity could include undertaking specific transactions, or it could include having interactions with third parties on an entity’s behalf, e.g. negotiating a contract. Where there are specific transactions that are undertaken between the principal and the third parties, the agent would be involved in facilitating or executing the transaction but would not be responsible for fulfilling the rights and obligations in the transaction. A key characteristic of these transactions is often that the principal and the third parties are the counterparties to the transaction rather than the agent and the third parties (although there are exceptions).

In analysing who the parties are to the arrangement, it is also important to note that there may be more than one principal-agent relationship in a single binding arrangement. This is particularly the case when there is a beneficiary in the relationship, as well as service providers that are used to provide goods and services to the beneficiaries in the relationship.

In assessing whether a principal-agent arrangement exists, an entity applies the principle of substance over form. Arrangements might stipulate that “this arrangement is (or is not) a principal-agent arrangement”, or “entity X is (or is not) the agent and entity Y is (or is not) the principal”, or that an entity “acts on behalf of XXX or is the implementing agent”. An entity needs to assess if the definition of a principal-agent arrangement in GRAP 109 is met when accounting for the arrangement, irrespective of the terminology used in the binding arrangement.

Only once an entity has concluded that a binding arrangement is a principal-agent arrangement as defined in GRAP 109, it will assess whether it is the principal or the agent in the arrangement.

See previous posts on this topic.

The Secretariat has issued FAQ 3.12 on accounting by principals and agents. Access it here.