Simplified Version of Indian Accounting Standard 115, Revenue from contract with customer
To which entity Ind-As is applicable?
- Net Worth = Paid-up share Capital + all reserves out of profit & securities premium account –accumulated losses – deferred expenditure – miscellaneous expenditure not written off
Reserves created out of revaluation of assets and written back depreciation shall not be included in net worth calculation.
- The net-worth and turnover shall be calculated as per last balance sheet prepared in accordance with accounting standard.
Which are the contracts that are out of scope of Ind-AS 115
This Ind AS will be applicable only when contract is made with the customers. Further it will not be applicable to Lease contracts as Ind-AS 116 will be applicable, it will not be applicable to Insurance Contracts in that case Ind-AS 104 will be applicable, and it is also not applicable to contract in relation financial instruments as in that case Ind-AS 109 will be applicable.
Further were entity is engaged in same line of business and has undertaken transaction in non-monetary terms to facilitate sales to customer then in that case this Ind-AS is not applicable. Non-monetary transaction is those transaction which doesn’t involves flow of money.
Illustration: Rajesh & Refinery Ltd. is engaged in business of petroleum refinery he has to deliver 10,000-liter petrol to one of its customers situated in cochin; Tushar and & Refinery one if the leading giant in petrol refinery business is also engaged in refinery business; Tushar industry has received an same order from Delhi were one of the branch of Rajesh & Refinery Ltd. is situated; to avoid transportation cost both companies has established mutual understanding and supplied the goods to the nearest location. Whether to this transaction Ind-AS 115 will be applicable?
In the given case where goods are been supplied by each party to facilitate sales of other party; transaction will be treated as non-monetary transaction carried out to facilitate sales where entity is engaged in same line of business and Ind-AS 115 will not be applicable to this arrangement but both the party is required to apply Ind-AS 115 while recognizing revenue from main contract entered with customer.
What if in given case one of the parties was engaged in business of transportation and service of transportation is provided to each other for no consideration. Whether in that case it will be covered under Ind-AS 115 as transaction is non-monetary.
In that case even if consideration to transaction is non-monetary however other condition are not satisfied and there Ind-AS 115 will be applicable in that case.
What are the steps that are required to be fulfilled in case contract is to be recognized under Ind-AS 115?
What if entity has already received consideration and any of the condition is not been satisfied?
In case where contract with a customer does not meet the recognition criteria and an entity receives consideration from the customer the entity shall recognize the consideration received as revenue only when either of the following events is fulfilled.
What are the factors that are important while determining transaction price in step three prescribed above?
Fixed Consideration: The amount of fix consideration shall be recognized as when entity fulfills the promised performance obligation.
Variable Consideration: In case where consideration promised in a contract includes a variable portion i.e. entity is required to estimate the amount of consideration to which the entity will be entitled in exchange for transferring the promised goods or services to a customer; there are two methods for estimating such amounts
Illustration : Mr. Rahul who is a builder is promised by his client that if Mr. Rahul fulfils the contract before 15 days from due date then in that case, he will be eligible to receive an additional bonus of Rs. 3,00,000/-. How much shall be recognized by Mr. Rahul in form of revenue as per Ind-AS 115?
In the given case best method for recognizing revenue will be most likely amount as only two probable outcomes are possible and based on entity’s estimation, they shall recognize revenue for the said contract.
What if in above situation bonus was to be paid as; if contract is completed before 15 days Rs. 3,00,000/- will be paid if contract is completed before 10 days then Rs. 1,50,000/- will be paid, if contract is completed before 5 days then Rs. 50,000/- will be paid. How much shall be recognized by Mr. Rahul in form of revenue as per Ind-AS 115?
In the given case as more than two outcomes is possible there for best method for recognizing variable consideration is expected value method. Against probability of receiving amount expected amount to be realised is multiplied.
However, entity shall note once the method is applied to particular contract it cannot be changed subsequently i.e. method adopted by entity shall be applied consistently for the particular contract.
Non-Cash Consideration: Consideration may be in the form of goods, services or other non-cash consideration (e.g., property, plant and equipment or a financial instrument). In case of contracts involving consideration in a form other than cash, such non-cash consideration shall be measured at fair value. An entity will likely apply the requirements of Ind AS 113, Fair Value Measurement when measuring the fair value of any non-cash consideration. If an entity cannot reasonably estimate the fair value of the non-cash consideration, the entity shall measure the consideration indirectly by reference to the stand-alone selling price of the goods or services promised to the customer (or class of customer) in exchange for the consideration.
Consideration consisting financial component: Whenever entity enters into transactions that includes terms in the nature of financing, which requires separate accounting and consideration of time value of money i.e. credit period offered to customer is higher than normal industry practice, then entity is effectively providing finance to the customer. In such case standard requires that while determining the transaction price, an entity shall adjust the promised amount of consideration for the effects of the time value of money if there is significant benefit to either party due to such component. However, as a practical expedient, an entity need not adjust the promised amount of consideration for the effects of a significant financing component if the entity expects, at contract inception, that the period between when the entity transfers a promised good or service to a customer and when the customer pays for that good or service will be one year or less. An entity shall present the effects of financing (interest revenue or interest expense) separately from revenue from contracts with customers in the Statement of Profit and Loss.
What are the cases when contract is to be treated as combination of contracts?
An entity shall combine two or more contracts entered into at or near the same time with the same customer (or related parties of the customer) and account for the contracts as a single contract if one or more of the following criteria are met :
What if there is modification in contract?
A contract modification exists when the parties toa contract approves a modification that either creates new or changes existing enforceable rights and obligations of the parties to the contract. A contract modification could be approved in writing, by oral agreement or implied by customary business practices. If the parties to the contract have not approved a contract modification, an entity shall continue to apply this Standard to the existing contract until the contract modification is approved.
If both the conditions are satisfied then in that case entity is required to account such contract as a separate contract. Conditions are as follows:
Illustration: Mr. Ajay is having business of sale of sarees; he got an order from one of its customers to provide 100 designed material sarees at the price of Rs. 500/- per piece. After delivering 50 sarees the contract was modified and additional 100 sarees were order at the price of Rs. 450/- per piece. The entity has policy that it offers discount of Rs. 50/- in case number of sarees purchase exceeds 120 pieces. How this contract shall be accounted by Mr. Ajay under Ind-AS 115?
In the above case as both the condition i.e. the scope of the contract increases because of the addition of promised goods or services that are distinct and are required to be supplied and the price of the contract increases by an amount of consideration that reflects the entity’s stand-alone selling prices of the additional promised goods or services after any appropriate adjustments to that price to reflect the circumstances of the particular contract. Therefore, contract will be treated as separate contract.
What if above conditions are not satisfied?
Entity shall treat such as if it were a termination of the existing contract and the creation of a new contract
Case 1: Where remaining goods and service are distinct from the goods or services transferred on or before the date of the contract modification. The amount of consideration to be allocated to new contract i.e. to remaining performance obligation will be total of additional consideration promised by customer after contract modification. Consideration that was promised by customer and was in included previous transaction price (i.e. consideration already received) but was not recognised as revenue.
Illustration: Mr. DK is having business of sale of high-quality machine and manufacturing of the same; he got an order from one of its customers to provide 10 machines at the price of Rs. 50,00,000/-. After delivering 5 machines the contract was modified and it was decided that now Mr. DK will only raw parts for another 10 machines additional portion will be provided to entity Rs. 40,00,000/-. Standalone selling price of such parts are Rs. 5,00,000/- per machine raw parts. How this contract shall be accounted by Mr. Ajay under Ind-AS 115?
In the given case contract does not satisfied one of the conditions that the price of the contract increases by an amount of consideration thatreflects the entity’s stand-alone selling prices of the additional promised goods or services after any appropriate adjustments to that price to reflect the circumstances ofthe particular contract. Therefore, entity is advised that not to treat as separate contract and revenue in relation to such contract can be recognised as follow(Additional consideration + consideration not recognised in earlier portion) i.e. Rs. 65,00,000/- (25,00,000 which is not recognised earlier + 40,00,000 additional consideration).
Case 2:Where remaining goods and service are not distinct from the goods or services transferred on or before the date of the contract modification.if the remaining goods or services are not distinct then it will form part of a single performance obligation that is partially satisfied at the date of the contract modification. In that case revenue will be recognised as if it is continuation of contract i.e. service provided till date and consideration received will be merged and will be treated as single contract.
What if entity is also liable to pay consideration to its customer against the services procured from its customer?
In that case consideration payable to a customer may include cash amounts, credit or other items that can be applied against amounts owed to the entity. An entity needs to determine whether consideration payable to a customer represents a reduction of the transaction price, or it is a payment for a distinct good or service. Entity is requiring to determine whether it can reliably measure fair value of goods and service received if yes; then whether the said payable amount exceeds the fair value of the goods and service received if yes; then the excess payment shall be treated as reduction of transaction party that entity has determine in exchange of goods and service promised by it. The amount other than excess amount will be treated as price of goods or service received by entity. However, if fair value of the goods and service received cannot be estimated reliably then in that case consideration payable itself is treated as reduction in transaction price i.e. to be received by entity.
What if the transfer of goods or service is continues supply or it is over the period of time?
In such case revenue is to be recognise over time. However, for said recognition any of the one condition is to be satisfied:
Whether Transaction price includes any amount which is collected on behalf of Government?
The transaction price is the amount of consideration to which an entity expects to been titled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties. The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both.
When entity is providing two or more service for single consideration how transaction price can be allocated?
In such case entity can allocate transaction price based on relative stand-alone selling price basis (stand-alone selling price is the price at which an entity would sell a promised good or service separately to a customer) and in case if stand-alone selling price is not directly observable, an entity shall estimate the stand-alone selling price
Case 1: Allocation based upon standalone selling price: Entity shall determine the stand-alone selling price at beginning of contract of the distinct good or service underlying each performance obligation in the contract and allocate the transaction price in proportion to those stand-alone selling prices.
Illustration: M/s Radhe Industry has sold bunch of goods for single consideration of Rs. 5,00,000/-. Standalone selling price of Product A is 2,00,000/-, of Product B is 3,00,000/- and of Product C is 1,00,000/-. In such case how such consideration is bifurcated for recognition of revenue as per Ind-AS 115.
In the given case entity can recognise revenue by allocating transaction price base upon standalone selling price of the product (because standalone selling price of the product is available) i.e. When product A is transferred entity shall recognise revenue of Rs. 1,66,660/- (Approx.) When product B is transferred entity shall recognise revenue of Rs. 2,50,000/- (Approx.) When product C is transferred entity shall recognise revenue of Rs. 83,340/- (Approx.)
Case 2: Allocation when standalone selling price of products transferred by entity is not available: If a stand-alone selling price is not directly observable, an entity shall estimate the stand-alone selling price and while determining such entity shall consider all the observable inputs that are available with entity. Such approaches may be as follows:
Expected cost plus a margin approach: An entity could forecast its expected costs of satisfying a performance obligation and then add an appropriate margin for that good or service.
Adjusted market assessment approach: An entity can identify the market in which it sells goods or services and estimate the price that a customer will be willing to pay for those goods or services. In such case entity may also take reference of price of its competitors for similar goods or services and adjusting those prices as necessary to reflect the entity’s costs and margins.
Residual Method: In case if any of above methods is not possible for allocation of transaction price where standalone selling price is not available then in that case entity may use combination of above methods and can also determine the transaction price by taking reference of the total transaction price less the sum of the observable stand-alone selling prices of other goods or services promised in the contract.
What are the costs that entity shall always recognise as expenses?
In case if there is abnormal loss in form of wasted materials, labour or other resources to fulfil the contract that were not reflected in the price of the contract, general and administrative expense, cost relating to satisfied performance obligation in the contract, cost were entity is unable to segregate whether the costs relate to unsatisfied performance obligations or to satisfied performance obligations.
How revenue is to be recognised in case of sale with right to return?
In many of the contracts it has an option to customer that it can return the goods to the entity and can claim refund. Therefore, entity needs to determine whether such sale is in form of consignment sale if not then revenue will be recognised as follows:
How entity shall deal with warranty liabilities?
In general, large number of contracts have warranty clause; the main issue that arises is how to recognise this in books of account in accordance with Ind-AS 115. Generally, there are two types of warranty; One type of provide a customer with assurance that the related product will function as the parties intended (in case product manufactured in accordance with customer specification); and another were customer is provided with a service in addition to the assurance that the product complies with agreed-upon specifications.
However, in both the case if customer has separate option to purchase warranty then the contract will be treated as separate contract then in that case promised service will be warranty service and consideration received will be treated as transaction price.
In other cases, i.e. other than those specified above where customer does not have the option to purchase a warranty separately, an entity shall account for the warranty in accordance with Ind AS 37, Provisions, Contingent Liabilities and Contingent Assets. In that case entity will determine expected amount that it will be liable to pay to fulfil the performance obligation based on entity’s past experience or normal practice followed in industry.
Now if warranty provides a customer with a service in addition to the assurance that the product will comply with agreed-upon specifications, the promised service is also a performance obligation. Then in that case entity shall allocate the transaction price to the product and the service and if entity promises both an assurance-type warranty and a service-type warranty but cannot reasonably account for them separately, then entity shall account for both of the warranties together as a single performance obligation.
Illustration: M/s Arjuna Traders is dealing in business of washing machine. He provides customer with an option that it will provide warranty for three months; every customer has an option that it can purchase additional warranty for 12 months if he is willing to pay additional consideration of Rs. 2,000/-. Who such revenue will be recognised as per Ind-AS 115?
In the given case there are two type of warranty agreement’s, first where there is fixed warranty of 3 months such will be recognisedin accordance with Ind AS 37, Provisions, Contingent Liabilities and Contingent Assets. i.e. entity will determine expected amount that it will be liable to pay to fulfil the performance obligation based on entity’s past experience or normal practice followed in industry.
The second option of purchasing additional warranty is case where customer has separate option to purchase warranty; Therefore, it will be treated as separate contract and promised service will be treated as separate performance obligation and consideration of Rs. 2,000/- will be treated as transaction price.
What if entity provides customer and voucher or additional option where they can acquire goods at discounted price or for free?
In case where contract gives right to customer to acquire additional goods or services, which creates performance obligation for the entity if right is exercised (i.e. it shall be material right; where chances of exercising rights are higher) then customer in effect pays the entity in advance for future goods or services and the entity recognises revenue when those future goods or services are transferred or when the option expires. However, if a customer has the option to acquire an additional good or service at a price that would reflect the stand-alone selling price for that good or service, that option does not provide the customer with a material right. Such offer will be treated as marketing offer and it will not create any performance obligation on entity.
Now, the question arises whether entity has entered into the contract that provides right to customer for additional goods and service at free of cost or at discounted rate; In such case entity shall allocate the transaction price to performance obligations on a relative stand-alone selling price basis. In case where entity’s provides customer’s option to acquire additional goods or services and such right is directly not observable whether entity will exercise or not then in that case, entity shall estimate probability of exercising the option.
Illustration: Mr Raj is running a huge store and is providing discount of 20% of purchase price to all its customer; however, if any of the member is purchasing goods worth Rs. 5,000/- or more then additional 10% discount is offered over an above the normal discount when customer visits next time and purchases goods worth Rs 2,000/- (Maximum discount available will be Rs.3,000/-). One of its customers has purchase goods worth Rs. 6,000/-; entity estimates 70% chance that customer will exercise the option and will get the benefit of 50% of offer price. Entity is of the question that how revenue shall be recognised in accordance with Ind-AS 115?
In the given case first entity is required to compute post discount price which will be Rs. 4,800/-. Now entity is required to determine discount that customer will receive one next purchase and probability that customer will avail such offer. Therefore, revenue received by entity will be divided into two-part i) Revenue received in respect of goods supplied by entity and ii) Right that is transferred to customer and which creates obligation on entity. In the given case portion allocated to future obligation will be Rs. 1,050/- (3,000*70%*50%). This portion will be recognised as liability and after completion of offer period will be recognised as revenue and the remaining amount will be immediately recognised as revenue i.e. Rs. 3,750/-.
How entity is required to deal with non-refundable upfront fees?
Firstly, entity is required to differentiate between deposit and non-refundable fees in case if entity has received non-refundable deposit then entity is required to determine whether he is required to transfer any goods or service in respect or same or any service is to be provided in respect of receipt of such non-refundable fees then entity shall recognise such fees as revenue only when such performance obligation is satisfied. If such is satisfied over the period of time then in that case revenue is also to be recognised over the period of time. In entity has no obligation against such fees then such shall be recognised as revenue or such can also be recognised as revenue in pattern of cost of setting up the contract is received. Also, any amount received as deposit by entity will not be treated as revenue and for its treatment amortised cost method as prescribed under Ind-AS 109 shall be adopted.
There are many practical aspects which are required to be taken care while recognising revenue under this Ind-AS. Also, revenue recognition is important area because it decides how entity will be liable to various laws and regulation. Our experts are continuously engaged in resolving such difficulties in best possible manner.