Revenue recognition is one of the most important accounting standard that make the direct impact on the financial performance of the company. Ind AS 115 lays down new requirements and rules in many aspects of revenue recognition, which are, either, new or significantly different than accounting principles under existing revenue recognition standards. The standard is applicable from accounting periods beginning on or after 1st April 2018, Implementation of Ind AS 115 Improves comparability of revenue across entities, industries, global capital markets, As per IND AS-115 revenue will be recognized in the event of Transfer of control of goods and services replacing earlier condition of transfer of Risk and Rewards. which is better suited for measurement of revenue and has introduced a new, five step, revenue recognition model.
IND AS-115 is applicable from 1st April 2018, AS-11 (Construction cost) and AS-18 (Revenue recognition) and separate guidance note for real estate developer get withdrawn and AS-115 become mandatory for real estate company.
As per IND AS-115 revenue will be recognized in the event of Transfer of control of goods and services replacing earlier condition of transfer of Risk and Rewards. We can understand this from one example:
Buyer X ask seller Y to make one item as per his specifications and also store in his warehouse, As per terms and condition Buyer pick the item whenever it is required by him, As per AS-9 revenue will be recognized once item is transferred to Buyer while as per IND AS-115 there are two performance obligation in the contract, One for Manufacturing of goods as per specifications second Storage of goods and Insurance to avoid any risk. Once supplier Y made goods /item ready and inform to customer about its readiness (control of goods transferred in favor of customer, buyer can pick its items when he desire), its performance obligation get completed and it can book / recognizes its revenue and when second obligation of storage obligation is over, it can book revenue for second obligation.
The standard shall be applied to all contracts with customers, except the following:
a) lease contracts within the scope of Ind AS 17, Leases;
b) insurance contracts within the scope of Ind AS 104, Insurance Contracts;
c) financial instruments and other contractual rights or obligations within the scope of Ind AS 109, Financial Instruments, Ind AS 110, Consolidated Financial Statements, Ind AS 111, Joint Arrangements, Ind AS 27, Separate Financial Statements And Ind AS 28, Investments in Associates and Joint Ventures; and
d) non-monetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers. For example, a contract between two oil companies that agree to an exchange of oil to fulfill demand from their customers in different specified locations on a timely basis.
Under this standard Revenue is five steps model, when any transaction fulfill all these steps than only revenue can be recognized
Step -1 – Identify Contract with Customer
Step -2– Identify Performance Obligation
Step -3 – Identify Consideration (in Exchange of goods / Services)
Step -4 –Allocate Transfer Price to Performance Obligation
Step -5 –Recognize Revenue
Step -1 – Identify Contract with Customer
in this step company should ensure that there is enforceable contract and should not be cancellable unilaterally
There must be price, terms and condition and There must be expectation of completion of performance obligation and receipt of consideration, Besides all of this contract should be in scope of this IND AS collaboration agreement, sale of PPE are not come in scope of this IND AS.
Step -2 – Identify Performance Obligation
A. What are the performance obligation in Contract ?
B. Whether there is one Performance Obligation or more than one Performance obligation ?
Goods and services are considered as one if following conditions are satisfied :
I. Entity emphasis on significance of Integration,We can understand this with following examples:
a. In airlines like in Jet Airways, Air Travel cost and Food cost can be called integration of Goods and Services
b. Similarly In Hotels, one day room charges and breakfast cost can be called integration of Goods and Services
II. One or more Goods and services modify significantly other Goods and Services, For Example
Sale of Car with three free services : If company do not provide free services the performance of car may effected so though there are two goods and services but can’t be said as distinct as there is one performance obligation
Purchase of Truck and Body Making of Truck : Mr X want to purchase truck from Tata show room, Tata has another division for making truck Body but Tata showroom does not insist for body making of truck, it is as per customer discretion whether he want to make body from Tata division itself or outside in the market . If customer order to make body with Tata division only then also, both transaction can’t be said as one transaction, both activities are inter-dependent and will be considered as separate transaction or separate performance obligation.
III. Goods and Services are highly interrelated / interdependent between themselves
If X got a contract from Government to make road, drain and footpath on the side of road, it may be separate contract but can’t be said separate performance obligation .as all performance obligation are interrelated and interlinked
Step -3 – Identify Consideration for each Performance Obligation (in Exchange of goods / Services)
One has to identify Transfer Price of each Performance obligation identified in Step -2 and check whether Variable consideration or Non Monetary consideration are part of total Consideration.
Variable Consideration
Escalation, Contingent Consideration, incentives, Penalties,volume Discounts are the form of Variable consideration Variable consideration is contingent upon future event and expressed in implied contracts including methods to measure the same, it can increase total consideration in form of Incentive, Bonus, escalation etc or decrease total consideration in form of penalties.
As per IND AS -115, If you are not certain of receiving any variable consideration, you will include it in your Transaction Price since inception . if you are not certain than you consider the assumption which is most probable . But in the next year Probability of variable consideration may change and that time you should make addition / reduction of variable consideration as per circumstances
For example I gave one contract to Mr X to make the building for which consideration was as under :
If X complete the Building in 3 years consideration will be 50 lacs
but if X complete the building in two years only than consideration would be 60 Lacs (10 Lacs more),
but if X complete the building in two and Half year only than consideration would be 55 Lacs (5 Lacs more),
but if X complete the contract in more than three year that he has to penalty of Rs 5 lacs and consideration would be only 45 lacs
In case of Multiple outcome we will compute Probability on weighted average method and include in Contract Transaction Prices
NON MONETARY CONSIDERATION
If significant financing component exist in contract, time value of money should be considered for determining transaction prices. Let say Credit period allowed to one customer is two year and total consideration charged from customer is one lacs, entity would required to compute notional finance cost charged to customer, say at the rate of 10% interest cost of two years are 20K So out of total consideration charged from customer, only 80K would be recognized as revenue from sales proceeds and 10K would be recognized as Interest income in 1st year and 10K in another year. It is quite possible that earlier entity recognized revenue of Rs 1 lacs upfront.
Similarly if customer has given an advance, again the notional finance cost need to be computed and revenue need to be adjusted, if advance given up to one year and credit period is also one year, in such case company may not able to find time value of money.
Step : 4 & 5 –Allocate Transfer Price to Performance Obligation and Recognition of Revenue
Transfer price Allocation depends upon the satisfaction of Performance Obligation . so before Allocation of TP, it is necessary to decide whether there is Single Performance Obligation or Multiple Performance Obligation
Satisfaction of Performance Obligation :
| At Point of Time if | Over a Period of time if |
Examples : Purchase of office equipment, Purchase of vehicle etc |
Examples : AMC Contract, Crane Purchase with specific configuration |
It can be understand from one more example :
If X purchase one Ready to move flat, than it is the example of satisfaction of Performance obligation at point of Time but if X ask contractor to make flat as per his configuration over a period of time than It is the example of Performance obligation over a period of time, if buyer cancel the order unilaterally, and service Provider / supplier can ask for payment of work already done than it is the example of Performance obligation over a period of time .
Method of Revenue Recognition in case of performance obligation is satisfied over a period of time
Earlier Accounting Standard AS-7 recommends only Input Based Method but IND AS-115 recommend three method for Revenue Recognition
| INPUT BASED METHOD | OUTPUT BASED METHOD | NO PROFIT-NO LOSS METHOD / COST Method |
| = Cost Incurred / Total cost to be incurred | = Value of Goods or Services Transferred to customer / Total value of Goods or Services to be transferred | =Cost incurred to date |
Example of Input Method and Output Method
Suppose M/s X ltd get contract for Rs 100 cr out of which 30 cr is material cost and 40cr is Service cost and 30cr is other cost, Mr X Purchase Material of Rs 30 cr and as per old accounting standard he could recognized revenue for 30% of cost incurred while As per IND AS 115 M/s X can book revenue only in proportion of work completed .
Let say M/s X ltd Get a contract to build 100 KM Road and it has completed 50 Km road in first year itself but it is wrong to say that X ltd has completed 50% of its work since in rest 50 km road passes through Hills where X ltd has to cut the rocks and has to make tunnel so it this case Input method will not show correct picture so one should used Output method to recognized revenue
Note:
Value of Good transferred can be identified through physical survey method, milestone achieved and certification of work by third party agencies
When revenue is directly related to Performance completed, output method is recommended
Whatever method once adopted, will be used consistently
COST METHOD / No Profit –No Loss Method
This method is used when entity can’t measure the work completed reliably and Entity is sure that it get consideration against cost incurred from contractee.
Let say M/s X Ltd get one contract for laying 5000 miles sea cable between INDa and Thailand . No company has laid the cable on that route earlier so it is not feasible to anticipate what difficulties it will face in laying the cable so in such case percentage of completion can’t be estimated so whatever cost has been booked will be considered as revenue. Suppose after two years X Ltd completed 4000 miles and now it can approximate percentage of completion, X ltd will book / recognized revenue using input method accordingly.
IND AS 115 vs IFRS 15
IND AS 115 excludes penalties from variable consideration and provides specific accounting treatment in case of penalties
IND AS 115 requires an entity to present separately the amount of excise duty included in the revenue recognized in the statement of profit and loss
IND AS 115 require an additional disclosure as compared to IFRS 15, under the new standard entities are required to present reconciliation of the amount of revenue recognized in the statement of profit and loss with the contracted price showing separately each of the adjustment made to the contract price specifying the nature of amount of each such adjustment separately
IND AS 115 provides additional guidance on accounting treatment in case of transfer of control of a product to a customer with an unconditional right of return
SUMMARY
Implementation of new revenue recognition standard is a welcome move considering convergence of revenue recognition policy with that globally accepted IFRS 15 but this Ind AS 115 differs considerably as compared to existing accounting principles for revenue recognition. Transition to new revenue recognition standard is not only an accounting change but is like to have significant impact on the entity’s data, systems and processes..
This differences significantly impact the changes in the identification of performance obligations, timing of revenue recognition, measurement of transaction price and disclosures.
Author Bio
Excellent Article by CMA Virendra Chaturvedi