The Ministry of Corporate Affairs (MCA), on 28 March 2018, notified Ind AS 115, Revenue from Contracts with Customers (which is based on IFRS 15, Revenue from Contracts with Customers) as part of the Companies (Indian Accounting Standards) Amendment Rules, 2018.
The new standard is effective for accounting periods beginning on or after 1 April 2018, thus aligning the Ind AS 115 applicability date with the IFRS applicability date i.e. 1 January 2018.
Ind AS 115 replaces existing revenue recognition standards Ind AS 11, Construction Contracts and Ind AS 18, Revenue and revised guidance note of the Institute of Chartered Accountants of India (ICAI) on Accounting for Real Estate Transactions for Ind AS entities issued in 2016.
The new standard also modifies other Ind AS for e.g. Ind AS 16, Property, Plant and Equipment for determining the date of sale of Property, Plant and Equipment (PPE) i.e. date of disposal of an item of PPE is the date the recipient obtains control of that item in accordance with Ind AS 115.
Scope of IND AS 115
The new standard applies to contracts with customers to deliver goods or services, except when those contracts are for:
- Lease contracts under Ind AS 17, Leases
- Insurance contracts under Ind AS 104, Insurance contracts
- Rights or obligations that are in the scope of certain financial instrument guidance for example IND AS 109
- Non-monetary exchanges between entities in the same line of business which facilitates sales to customers other than parties to the exchange.
Fundamental principle of Ind AS 115
The fundamental principle of the new standard is that revenue should be when an entity transfers controls of goods or services to a customer at the amount to which the entity expects to be entitled. To achieve the core principle, the new standard establishes a five – step model framework that entities would need to apply to determine when to recognize revenue and amount. The new approach is likely to bring significant changes in the way companies recognize, present, and disclose their revenue.
?StepI-Identify the contract with Customer.
?StepII-Identify performance obligation in the contract
?StepIII–determine the transaction price
?StepIV-Allocate the transaction price to the performance obligation
?StepV-Recognize revenue when the entity satisfies its performance obligations
The underlying assumptions is transfer of risk and rewards model to a five-step approach which primarily focuses on transfer of control of goods and services by an entity under a contract with its customers.
Step I - Identify the contract with the customer
The new standard defines a“Contract” as an agreement between two or more parties that creates enforceable rights and obligations and specifies that enforce ability is a matter of law. Contracts can be written, oral or implied by an entity’s customary business practices.
Contract with a customer exists when it meets all of the following criteria.
?Collection of consideration is considered as probable.
?Thereisa commercial substance.
?Righttogoods or services and payment terms can be identified ?It’sapproved and the parties are committed to their obligations.
Step II – Identify the performance obligations
The new standard requires an entity to identify the performance obligations. Promise to deliver goods or provide a service in a contract with a customer constitutes a performance obligation if the promised good or service is distinct.
A promised good or service is distinct from other goods and services in the contract if meets two criteria.
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Criteria 1 : Capable of being distinct |
Criteria 2 : Distinct within the context of |
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Customer can benefit from the goods or |
contract |
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services on its own or together with other |
Promise to transfer good or service is |
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readily available resources |
separately identifiable from other promise in |
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the contract |
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Yes |
No |
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Distinct performance obligation |
Not distinct – combine with other |
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goods and services |
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Step III – determine the transaction price
Ind AS 115 requires an entity to consider the terms of the contract and its customary business practices to determine the transaction price. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring goods or services to a customer.
Following factors shall be considered when determining transaction price:
?Iftheconsideration includes variable amount, an entity should estimate the amount of consideration to which it will be entitled in exchange for transferring the promised goods or services to a customer.
?Indetermining the transaction price, an entity should adjust the promised amount of consideration for the time value of money if significant financing component exist.
?Noncash consideration is measured at fair value, if that can be reasonably estimated.
?Entitiesneed to determine whether consideration payable to a customer represents a reduction of the transaction price, a payment for a distinct goods or service, or a combine of the two.
Step IV - Allocating the transaction price
Under Ind AS 115, entities are required to allocate the transaction price to each performance obligation in proportion to its stand-alone selling price i.e. the price at which an entity would sell the promised good or service separately to customer.
The best evidence of the stand -alone selling price is an observable price from stand -alone sales of that goods or service to similarly situated customers. Entity shall estimate the stand-alone selling price using the following methods:
?Expected cost plus marging approach
?Residualapproach
?Adjusted market assessment approach
Step V - Recognise revenue
Revenue may be recognized either at a point in time or over a period of time. For the purpose of standard, control refers to the customers ability to direct the use of and obtain necessary benefits from the asset.
An entity would have to determine at contract inception whether it satisfies the performance obligation over time or at a point in time.
At the end of each reporting period, for each performance obligation satisfied over time, revenue should be recognized by measuring the progress towards complete satisfaction of that performance obligation. An entity should use a single method consistently for such measurement. Ind AS 115 specifies two types of methods: input method and output method, which an entity should consider based on the nature of the goods or services. The objective is to use a method which depicts the transfer of control of goods or services to the customer.
When to recognize revenue:
Has any of the following criteria fulfilled:
Customer receives / consumes as the simultaneously entity performs.
Entity creates / enhances an asset and customer controls it during this process
Created asset has to the entity + no alternative use the entity had for enforceable right to payment performance up to date
YES NO
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Revenue overtime – |
Revenue at the Point of |
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When control is |
time – Based on |
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transferred |
progress |
Key Challenges for Industries
?Therevenue and profit recognition will change for some entities and they will need to consider ?whether revenue should be recognised over time or at a point in time ?howshipping term will change the timing of recognition
?theextent to which distinct goods or services are supplied, which should be accounted for
separately
?whether costs relating to obtaining a contract must be capitalised ?whether revenue must be adjusted for the effects of the time value of money ?howtoaccount for contract modifications
?theimpact of new guidance where pricing mechanisms include variable amounts ?whether accounting treatment will be changed for different types of licenses and royalties ?accounting for warranty covers given to customers
Other Issues :
?Theaccounting for contract modifications is complex and differs significantly depending on whether a new performance obligation is created and, on the pricing
?Revenues from manufactured goods may historically have been recognized on delivery to the customer. Now, if the contract meets the 'over time' test, then the revenue would be recognized as the manufacturing happens – like current longterm contract accounting.
?Cashincentives and incentives to provide free or discounted goods can be separate performance obligations rather than marketing incentives
?Non-performance penalties (e.g. for failure to meet service level agreements) will generally need to be deducted from revenue rather than charged as an expense
