International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) issued their long-awaited converged standard on revenue recognition in May 2014. These standards are required to be adopted by the IFRS and US GAAP reporters from 1 January 2018. The Ministry of Corporate Affairs (MCA) has notified Ind AS 115, 'Revenue from Contracts with Customers', on 28 March 2018, which is effective for accounting periods beginning on or after 1 April 2018.
Ind AS 115 is largely converged with IFRS 15 and ASC 606 issued by the IASB and FASB. The standard contains principles that an entity will apply to determine the timing and amount of revenue to be recognised. The underlying principle is that an entity will recognise revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. The standard could significantly change how may entities recognise revenue. The standard will also result in a significant increase in the volume of disclosures related to revenue recognition.
Ind AS 115 will supersede two standards Ind-AS 18 and Ind-AS 11 from 01.04.2018.
Impact of the new revenue standard
The impact of the new Ind AS revenue standard extends far beyond the finance function.
Revenue is one of the most important financial statement measures for both preparers and users of financial statements. The standard will require entities to apply judgement and use estimates in several areas. The new revenue standard may impact identification of performance obligations to be delivered, accounting for contract costs, accounting for right of return, and evaluation of principal-agent relations.
The new standard may have an impact on an entity’s budgeting and reporting process, IT systems, internal control systems. It may also have tax implications in many circumstances. The actual impact on each company will depend on their specific customer contracts and how they have applied existing Standards. For some it will be a significant shift, and systems changes will be required, while others may see only minor changes.
Under Ind AS 115, revenue is recognised when a customer obtains control of a good or service, while under existing principles of Ind AS, revenue is recognised when there is a transfer of risk and rewards. A customer obtains control when it has the ability to direct the use of and obtain the benefits from the good or service.
Entities will be required to apply the new guidance to determine whether revenue should be recognised ‘over time’ or ‘at a point in time’. So, a company will have to first determine whether control is transferred over time at a point in time. If Control is transferred over the time, then revenue should be recognised over the period otherwise when transfers the controls to the entity at a point of time.
The five-step revenue model
The core principle of Ind AS 115 is that an entity will recognise revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. This core principle is described in a five-step model framework:
Identifying the contract
A contract is identified when following criteria are met:
- Parties have approved the contract and are committed to perform their respective obligation
- Each party’s rights can be identified
- Payment terms can be identified for goods or services to be transferred
- Contract has commercial substance (Contract shall result in change in cash flow)
- It is probable to collect entitled consideration for goods or services to be transferred to the customer, customer’s ability and intention to pay is considered to evaluate collectability of consideration.
A contract does not exist when each party have unilateral right to terminate a wholly unperformed contract without compensating other party. A wholly unperformed contract means:
- Promised goods and Services are not transferred yet
- Agreed Consideration is not received or entitled to receive yet
When contract does not meet criteria and entity receives consideration from customer, consideration received shall be recognised as revenue when either of following events occurred:
- Obligation has been fulfilled, all or substantially all of the consideration paid which is non- refundable
- Contract has been terminated and consideration paid is non-refundable
If there is a change in the scope or price (or both) of a contract, then it should be treated as modification in contracts. A contract modification exists when the parties to a contract approve a modification that either creates new or changes existing enforceable rights and obligations of the parties to the contract.
An entity shall account for a contract modification as a separate contract or contract modification is not accounted for as a separate contract depending upon the changes on the facts and circumstances.
Identifying Performance Obligation
Identify as a performance obligation each promise to transfer to the customer either:
- a distinct good or service (or a bundle of goods and services)
- a series of goods and services that are substantially the same or have same pattern of transfer to customer.
Performance obligations do not include activities that an entity must undertake to fulfil a contract unless those activities transfer a good or service to a customer.
Promised good or service is distinct if following criteria are met:
- Customer can benefit from the good or service either on its own or together with other resources that are readily available to customer.
- Promise to transfer good or service to customer is separately identifiable from other promises in the contract.
If a promised good or service is not distinct, an entity shall combine that good or service with other promised goods or services until it identifies a bundle of goods or services that is distinct, in some cases, that would result in the entity accounting for all the goods or services promised in a contract as a single performance obligation.
Satisfaction of performance obligation
An entity shall recognise revenue when the performance obligation is satisfied by transferring a promised good or service to a customer. An asset is transferred when the customer obtains control of that asset.
Performance obligation satisfied over time
An entity transfers control of a good or service over time and, therefore satisfies a performance obligation and recognises revenue over time, if one of the following criteria is met:
- Customer simultaneously receives and consumes the benefit provided by the entity’s performance
- The entity’s performance creates or enhances an asset (e.g. WIP) that the customer controls as the asset is created or enhanced
- Entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date.
Performance obligation satisfied at a point in time
If a performance obligation not satisfied over time, an entity satisfies performance obligation at a point in time which is determined when customer obtains control of a promised asset and the entity satisfies a performance obligation.
Determine the Transaction Price
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. When a performance obligation is satisfied, an entity shall recognize as revenue the amount of transaction price.
Promised consideration includes fixed or variable amount or both (excluding variable consideration which is highly probable to be reversed from recognised revenue due to uncertainty resolved). Transaction price for contracts in which consideration is promised in a form other than cash, non-cash consideration is measured at fair value.
If consideration includes the variable amount, an entity shall estimate the amount of consideration to which the entity will be entitled in exchange for transferring promised goods or services to a customer. Consideration may vary due to discounts, rebates, refunds, credits or other similar items.
Amount of variable consideration shall be estimated by using either of following methods:
- The expected value- sum of probability weighted amounts in a range of possible consideration amounts.
- The most likely amount- the most likely amount is single most likely amount in a range of possible consideration amounts.
Method for estimating variable consideration is applied consistently throughout the contract.
The transaction price for contracts in which a customer promises consideration in a form other than cash, entity shall measure non-cash consideration at fair value.
If fair value of non-cash consideration can not be estimated reasonably, entity shall measure consideration by reference to the standalone selling price of goods or services promised to the customer in exchange of consideration.
Allocating the transaction price to performance obligations
The transaction price is allocated to each performance obligation in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer.
Incremental Cost of obtaining contract
Incremental cost of obtaining contract is recognized as an asset if entity expects to recover those costs.
Incremental cost of obtaining contract are those costs that an entity occurs to obtain a contract that it would not have been incurred if contract had not been obtained.
Costs to obtain a contract shall be recognized as an expense when incurred if:
- those costs are explicitly chargeable to customer regardless of whether the contract is obtained.
- The amortization period of the asset that the entity otherwise would have recognized is one year or less.
Costs to fulfill a contract
If the cost incurred in fulfilling a contract with a customer are not within the scope of another standard, an entity shall recognize an asset from the costs incurred to fulfill a contract only if those costs meet all of the following criteria:
- The costs relate directly to contract or to anticipated contract that entity can specifically identify
- Costs enhance or generate resources of the entity that will be used in satisfying performance obligation in the future
- Costs are expected to be recovered
Amortization and impairment
An asset recognized from costs to obtain or fulfill a contract shall be amortized on a systematic basis that is consistent with the transfer of the goods or services to which the asset relates. The asset may relate to goods or services transferred under an anticipated contract.
Impairment loss shall be recognized in profit and loss to the extent that the carrying amount of an asset recognized from incremental cost or cost to fulfil the contract exceeds:
- Remaining amount of consideration that the entity expects to receive in exchange for the goods or services to which the asset relates; less
- The costs that relate directly to providing those goods or services and that have not been recognized as expenses.
Recognition of Revenue
Performance obligation satisfied over time
An entity shall recognize revenue over time by measuring the progress towards complete satisfaction of obligation and progress is measured through entity’s performance in transferring control of goods or services promised to a customer.
At the end of each reporting period, an entity is required to measure its progress towards complete satisfaction of performance obligation satisfied over time. For measuring progress, a single method shall be applied consistently to similar obligation in similar circumstances.
Performance obligation satisfied at a point of time
An entity shall recognize revenue at a point of time at which a customer obtains control of a promised goods or services and entity satisfies a performance obligation.
Presentation and Disclosure
An entity shall present contract in Balance Sheet as a contract asset or a contract liability, depending on the relationship between entity’s performance and the customer’s payment. Any unconditional rights to consideration is presented separately as a receivable.
An entity shall disclose qualitative and quantitative information about all of the following:
- Its contracts with customers
- Significant judgements and changes in judgements made in applying this standard to those contracts
- Any asset recognised from the costs to obtain or fulfil a contract with customer.
- Disaggregation of revenue (revenue for each reportable segment)
- Opening and closing contract balances
- Performance obligation
- Transaction price allocated to remaining performance obligation
- Determining the timing of satisfaction of performance obligation
- Practical expedients (if an entity elects to use the practical expedient+, it will be disclosed)
Entities can apply one of the two transition methods:
- Retrospective: Retrospective application requires applying the new guidance to each prior reporting period presented. However, the standard provides certain practical expedients in applying the full retrospective method.
- Modified retrospective: The modified retrospective transition approach is intended to be simpler than full retrospective application; however, there are still challenges associated with that approach, including additional disclosure requirements in the year of adoption. These additional disclosures effectively require an entity to apply both the new revenue standard and the previous revenue guidance in the year of initial application. Entities should consider the needs of investors and users of the financial statements in deciding which transition method to follow.
Understanding of New Standard
Accounting policies/ Position Papers
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