Step 1 – Para 9 Identifying the contract:
An entity shall account for a contract with a customer that is within the scope of this Standard only when all of the following criteria are met:
(a) the parties to the contract have approved the contract (in writing, orally, or in accordance with other customary business practices) and are committed to perform their respective obligations;
(b) the entity can identify each party’s rights regarding the goods or services to be transferred;
(c) the entity can identify the payment terms for the goods or services to be transferred;
(d) the contract has commercial substance (i.e., the risk, timing, or amount of the entity’s future cash flows is expected to change as a result of the contract); and
(e) it is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. In evaluating whether the collectability of an amount of consideration is probable, an entity shall consider only the customer’s ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the entity will be entitled may be less than the price stated in the contract if the consideration is variable because the entity may offer the customer a price concession (see paragraph 52)
Step 2 – Para 22 Identifying the performance obligation:
At contract inception, an entity shall assess the goods or services promised in a contract with a customer and shall identify as a performance obligation each promise to transfer to the customer either:
(a) a good or service (or a bundle of goods or services) that is distinct; or
(b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer
Para 23 Explain – A series of distinct goods or services has the same pattern of transfer to the customer if both criteria are met:
(a) each distinct good or service in the series that the entity promises to transfer to the customer would meet the criteria in (paragraph 35) to be a performance obligation satisfied over time; and
(b) in accordance with paragraphs 39–40, the same method would be used to measure the entity’s progress toward complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer
Para 35 Performance obligations satisfied over time – An entity transfers control of a good or service over time and, therefore, satisfies a performance obligation and recognizes revenue over time, if one of the following criteria is met:
(a) the customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs (see paragraphs B3–B4);
(b) the entity’s performance creates or enhances an asset (for example, work in progress) that the customer controls as the asset is created or enhanced (see paragraph B5); or
(c) the entity’s performance does not create an asset with an alternative use to the entity (see paragraph 36) and the entity has an enforceable right to payment for performance completed to date (see paragraph 37).
Para 39-40 Measuring progress towards complete satisfaction of a performance obligation
For each performance obligation satisfied over time in accordance with paragraphs 35–37, an entity shall recognize revenue over time by measuring the progress towards complete satisfaction of that performance obligation. The objective when measuring progress is to depict an entity’s performance in transferring control of goods or services promised to a customer (ie the satisfaction of an entity’s performance obligation).
An entity shall apply a single method of measuring progress for each performance obligation satisfied over time & the entity shall apply that method consistently to similar performance obligations & in similar circumstances. At the end of each reporting period, an entity shall remeasure its progress towards complete satisfaction of a performance obligation satisfied over time.
Step 3 – Para 31 Satisfaction of performance obligations
An entity shall recognize revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (i.e. an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset.
Step 4 – Para 46-47 Measurement of transaction price
When (or as) a performance obligation is satisfied, an entity shall recognize as revenue the amount of the transaction price (which excludes estimates of variable consideration that are constrained in accordance with paragraphs 56–58) that is allocated to that performance obligation.
Determining the transaction price: An entity shall 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 promised goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some sales taxes). The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both
Para 53 Variable consideration an entity shall estimate an amount of variable consideration by using either of the following methods, depending on which method the entity expects to better predict the amount of consideration to which it will be entitled:
(a) The expected value—the expected value is the sum of probability-weighted amounts in a range of possible consideration amounts. If an entity has a large number of contracts with similar characteristics.
(b) The most likely amount—the most likely amount is the single most likely amount in a range of possible consideration amounts. The most likely amount may be an appropriate if the contract has only two possible outcomes
Step 5 – Para 76-77 Allocating the transaction price to performance obligations
To allocate the transaction price to each performance obligation on a relative stand-alone selling price basis, an entity shall determine the stand-alone selling price at contract inception 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
The stand-alone selling price is the price at which an entity would sell a promised good or service separately to a customer. The best evidence of a stand-alone selling price is the observable price of a good or service when the entity sells that good or service separately in similar circumstances and to similar customers. A contractually stated price or a list price for a good or service may be (but shall not be presumed to be) the stand-alone selling price of that good or service.
Para B83-86 Customer Acceptance – A customer’s acceptance of an asset may indicate that the customer has obtained control of the asset. Customer acceptance clauses allow a customer to cancel a contract or require an entity to take remedial action if a good or service does not meet agreed-upon specifications. An entity shall consider such clauses when evaluating when a customer obtains control of a good or service
Para B28-33 Warranties – If a 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.
Question 1 Entity A enters into a contract with Customer B to manufacture & install a product. These products need a significant amount of installation to make them operational and the installation will be done by the Entity A. Entity A dispatches these goods to Customer B to be installed later and raises an invoice of Rs.8,00,000 for these goods as at March 31, 2018. The standalone value of the product is Rs.7,00,000 and the installation is Rs.2,00,000. Assuming the installation is completed by June 2018, when should the revenue be recognized?
Response: Paragraph 22 of Ind AS 115 states that, “at contract inception, an entity shall assess the goods or services promised in a contract with a customer and shall identify as a performance obligation each promise to transfer to the customer either:
(a) a good or service (or a bundle of goods or services) that is distinct; or
(b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer
Further, paragraph 29 of Ind AS 115 states that “in assessing whether an entity’s promises to transfer goods or services to the customer are separately identifiable in accordance with paragraph 27(b), the objective is to determine whether the nature of the promise, within the context of the contract, is to transfer each of those goods or services individually or, instead, to transfer a combined item or items to which the promised goods or services are inputs”. In the given case, it needs to be ascertained whether the installation is complex and whether company A offers manufacturing and installation services in combination or separately to its customers.
In case the company offers these services in combination, and the customer cannot benefit from the installation services on its own or together with other readily available resources (for instance, only company A can install the product because of its complicated nature), then there is only one performance obligation. Additionally, the entity must also establish whether it satisfies the performance obligation at a point in time or over time, to satisfy conditions in paragraphs 35 and 36 of the Standard. Assuming the product cannot be used before installation and the customer cannot obtain the benefits of using the product before installation (i.e, the money received will have to be returned unless the installation of the product is successful), the performance obligation is satisfied at a point in time when installation is completed. Additionally, paragraph 31 of Ind AS 115 requires revenue from the sale of goods to be recognized when the control of goods has passed to the customer. Paragraph 33 of the Standard states that control of an asset includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset.
Thus, in such a case, the revenue of Rs.8,00,000 will be recognized when installation is complete, i.e., in June 2018. On the other hand, if the company offers these services individually and the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer, then there are two performance obligations:
(i) Sale of the product; and
(ii) Installation of the product
Rs.8,00,000 would be allocated to goods and installation services respectively in accordance with paragraph 76 of Ind AS 115 as per their stand-alone selling prices i.e., Rs.7,00,000 and Rs.2,00,000 respectively. Accordingly, the revenue from goods to be recorded for the year ended March 31, 2018, is Rs.6,22,222.22 (800000 x 700000/900000) and for installation services during the period ended June 30, 2018, is Rs.177,777.78
Author Bio
