Ind AS 115 (based on IFRS 15) Revenue from Contracts with Customers - Simplified

CA Kushal Soni 
on 25 May 2018


Ind AS 115, Revenue from Contracts with Customers (based on IFRS 15), notified on 28 March 2018 by MCA. The new standard is effective for accounting periods beginning on or after 1 April 2018.

Objective

To establish the principles that an entity shall apply to report useful information to users of financial statements about the nature, amount, timing and uncertainty of revenue and cash flows arising from a contract with a customer.

The new standard replaces following existing standards:

  • Ind AS 11, Construction Contracts
  • Ind AS 18, Revenue

Scope

An entity shall apply this Standard to all contracts with customers, except the following:

  1. lease contracts covered by of Ind AS 17, Leases;
  2. insurance contracts covered by Ind AS 104, Insurance Contracts;
  3. financial instruments and other contractual rights or obligations covered by 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
  4. non-monetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers.

This Standard is applicable only when counterparty to the contract is a customer. For example, developing the asset in a collaboration arrangement, both enitites work together and none of them are customer to each other.

If other specific standard apply on a contract with customer then entity shall apply that standard, not Ind AS 115.

Main principle of Ind AS 115

There is a paradigm shift from the present ‘transfer of risk and rewards model’ to a ‘five-step model’ which mainly focuses on transfer of control of goods and services.  Revenue should be recognised when (or as) an entity transfers control 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 that entities would need to apply to determine when to recognise revenue, and at what amount.

Five-step model

  • STEP 1: Identify contract
  • STEP 2: Identify performance obligations in the contract
  • STEP 3: Determine transaction price
  • STEP 4: Allocate transaction price to the performance obligations
  • STEP 5: Recognise revenue when the entity satisfies its performance obligations

Five-step model – Explanation

STEP 1: IDENTIFY CONTRACT

A contract is an agreement between two or more parties that creates enforceable rights and obligations. Contracts can be written, oral or implied by an entity’s customary business practices.

An entity shall account for a contract with a customer when all of the following criteria are met:

  1. 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;
  2. the entity can identify each party’s rights regarding the goods or services to be transferred;
  3. the entity can identify the payment terms for the goods or services to be  transferred;
  4. the contract has commercial substance (ie the risk, timing or amount of the entity’s future cash flows is expected to change as a result of the contract); and
  5. it is probable that the entity will collect the consideration

An entity shall apply this Standard to the duration of the contract (ie the contractual period) in which the parties to the contract have present enforceable rights and obligations.

A contract is wholly unperformed if both of the following criteria are met:

  1. the entity has not yet transferred any promised goods or services to the customer;
  2.  
  3. the entity has not yet received, and is not yet entitled to receive, any consideration in exchange for promised goods or services.

Consideration received from the customer shall be recognised as liability if:

  1. Obligation to transfer goods and services is still pending
  2. Consideration received form customer is refundable

Combination of contracts

An entity shall combine two or more contracts and account for the contracts as a single contract if one or more of the following criteria are met:

  1. contracts are negotiated as a package
  2. the amount to be paid in one contract depends on the price or performance of the other contract
  3. the goods or services promised in the contracts are a single performance obligation

Contract modifications

A contract modification is a change in the scope or price (or both) of a contract that is approved by the parties to the contract.

A contract modification could be approved in writing, by oral agreement or implied by customary business practices. A contract modification may exist even though the parties to the contract have a dispute about the scope or price (or both) of the modification

An entity shall account for a contract modification as a separate contract if both of the

following conditions are present:

  1. the scope of the contract increases because of the addition of promised goods or services that are distinct and
  2.  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.

An entity shall account for the contract modification as if it were a termination of the existing contract and the creation of a new contract, if the remaining goods or services are distinct, the consideration has not been recognised as revenue, the consideration promised as part of the contract modification.

An entity shall account for the contract modification as if it were a part of the existing contract if the remaining goods or services are not distinct and form part of a single performance obligation that is partially satisfied at the date of the contract modification

STEP 2: IDENTIFY PERFORMANCE OBLIGATIONS

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:

  1. a good or service (or a bundle of goods or services) that is distinct (one time contract); or
  2. a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer (continuous contract)

Depending on the contract, promised goods or services may include, but are not limited to, the following:

  1. sale of goods produced by an entity (for example, inventory of a manufacturer);
  2. resale of goods purchased by an entity (for example, merchandise of a retailer);
  3. resale of rights to goods or services purchased by an entity (for example, a ticket resold by an entity acting as a principal,
  4. performing a contractually agreed-upon task (or tasks) for a customer;
  5. making goods or services available for a customer to use as and when the customer decides;
  6. providing a service of arranging for another party to transfer goods or services to a customer (for example, acting as an agent of another party);
  7. granting rights to goods or services to be provided in the future that a customer can resell or provide to its customer (for example, an entity selling a product to a retailer promises to transfer an additional good or service to an individual who purchases the product from the retailer);
  8. constructing, manufacturing or developing an asset on behalf of a customer;
  9. granting licences; and
  10. granting options to purchase additional goods or services (when those options provide a customer with a material right).

Satisfaction of performance obligations

An entity shall recognise revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (ie an asset) to a customer.

An asset is transferred when (or as) the customer obtains control of that asset.

Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. Control includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset.

Methods for measuring progress towards complete satisfaction of a performance obligation

Appropriate methods of measuring progress include output methods (based on units produced or units delivered) and input methods (based on resources consumed, labour hours expended, costs incurred, time elapsed or machine hours used). Both methods have its own benefits and limitations.

Performance obligation can be satisfied in two ways:

  1. Over the period of time (recognise revenue over the period of time)
  2. At a point in time (recognise revenue at a point in time)

When (or as) a performance obligation is satisfied, an entity shall recognise as revenue the amount of the transaction price that is allocated to that performance obligation.

STEP 3: 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, GST). The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both.

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:

  1. The expected value—the expected value is the sum of probability-weighted amounts in a range of possible consideration amounts.
  2. The most likely amount—the most likely amount is the single most likely amount in a range of possible consideration amounts

An entity shall apply one method consistently throughout the contract

Refund liabilities

An entity shall recognise a refund liability if the entity receives consideration from a customer and expects to refund some or all of that consideration to the customer.

The existence of a significant financing component in the contract

In determining the transaction price, an entity shall adjust the promised amount of consideration for the effects of the time value of money if a significant financing component exist in the contract.

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.

Non-cash consideration

To determine the transaction price for contracts in which a customer promises consideration in a form other than cash, an entity shall measure the non-cash consideration at fair value.

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 in exchange for the consideration.

If a customer contributes goods or services (for example, materials, equipment or labour) to facilitate an entity’s fulfilment of the contract, the entity shall assess whether it obtains control of those contributed goods or services. If so, the entity shall account for the contributed goods or services as non-cash consideration received from the customer.

Consideration payable to a customer

Consideration payable to a customer includes cash amounts credit or other items (for example, a coupon or voucher).

An entity shall account for consideration payable to a customer as a reduction of the transaction price and, therefore, of revenue unless the payment to the customer is in exchange for a distinct good or service.

If consideration payable to a customer is a payment for a distinct good or service from the customer, then an entity shall account for the purchase of the good or service in the same way that it accounts for other purchases from suppliers. If the amount of consideration payable to the customer exceeds the fair value of the distinct good or service that the entity receives from the customer, then the entity shall account for such an excess as a reduction of the transaction price.

If the entity cannot reasonably estimate the fair value of the good or service received from the customer, it shall account for all of the consideration payable to the customer as a reduction of the transaction price.

STEP 4: ALLOCATING THE TRANSACTION PRICE TO PERFORMANCE OBLIGATIONS

Allocate the transaction price to each performance obligation (or distinct good or service) 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.

Allocation of a discount

Entity shall allocate a discount proportionately to all performance obligations in the contract.

Changes in the transaction price

An entity shall allocate to the performance obligations in the contract any subsequent changes in the transaction price on the same basis as at contract inception.

STEP 5: RECOGNISE REVENUE WHEN THE ENTITY SATISFIES ITS PERFORMANCE OBLIGATIONS.

Pre-condition to identify revenue is that entity shall satisfy its performance obligation. In case if performance obligation is satisfied over the period of time then revenue shall be spread over the same period of time. For recognition of revenue Ind AS 115 emphasize on transfer of control.


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