Ind AS 115 - Revenue From Contracts with Customers

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Introduction

As per the Ministry of Corporate Affairs notification on 16 February 2015 the first stage of implementation of Ind AS is to begin from 1 April 2016, with comparables for the period ending 31 March 2016.

India has adopted a strategy of “converging” into IFRS and not “adopting” the IFRS issued by the International Accounting Standard Board (IASB).

Adopting would mean that an outright policy would be issued that the standards issued by IASB will be the standards that will be followed in the country without any changes.

By adopting a strategy of “convergence” India can draft standards on its own which are in line with IFRS but some modifications to the IFRS issued by IASB can be made.

Thus as a result of this Indian Accounting Standards (IND AS) were drafted and issued, they are in line with IFRS with certain changes or “carve-outs” to reflect the economic and business conditions in India.

There are 39 IND AS notified by the Ministry of Corporate Affairs.

One of the IFRS is IFRS 15 Revenue from Contracts with Customers, the converged standard in the Indian context is Ind AS 115 Revenue from Contracts with Customers.

The aspect to be noted is that IASB has made IFRS 15 compulsorily applicable only from accounting periods beginning on or after 1 January 2018 (earlier application is allowed), but MCA has gone a step forward and made Ind AS 115 compulsorily applicable to the companies (as per the road map of convergence to IFRS (Ind AS)) from 1 April 2016.

Summary of the provisions of Ind AS 115 – Revenue from Contracts with Customers:

The standard defines Revenue as “income that arises in the course of ordinary activities”.

The five steps of the revenue recognition process:

1. Identify the contract with the customer.

2. Identify the separate performance obligations.

3. Determine the transaction price.

4. Allocate the transaction price to the performance obligations.

5. Recognize revenue when (or as) a performance obligation is satisfied.

Step 1: Identify the contract with the customer

An entity shall apply this Standard to a contract only if the counterparty to the contract is a customer.

Customer:

A customer is a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration.

A counterparty to the contract would not be a customer if, for example, the counterparty has contracted with the entity to participate in an activity or process in which the parties to the contract share in the risks and benefits that result from the activity or process (such as developing an asset in a collaboration arrangement) rather than to obtain the output of the entity’s ordinary activities

Contract:

The revenue recognition principles of Ind AS 115 will apply only when a contract meets all of the following criteria:

• the parties to the contract have approved the contract;

• the entity can identify each party's rights regarding the goods or services in the contract;

• the payment terms can be identified;

• the contract has commercial substance; and

• it is probable that the entity will collect the consideration due under the contract.

Some contracts with customers may have no fixed duration and can be terminated or modified by either party at any time. Other contracts may automatically renew on a periodic basis that is specified in the contract. 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.

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.

Commercial substance means that the risk, timing or amount of the entity‘s future cash flows is expected to change as a result of the contract.

Conditions for it to be a valid contract are assessed at the beginning of the contract and, if the contract meets them, they are not reassessed unless there is a significant change in circumstances that makes the contract rights and obligations unenforceable.

If a contract does not initially meet the criteria, it can be reassessed at a later date.

When a contract with a customer does not meet the criteria mentioned in above (Step 1) and an entity receives consideration from the customer, the entity shall recognize the consideration received as revenue only when either of the following events has occurred:

• the entity has no remaining obligations to transfer goods or services to the customer and all, or substantially all, of the consideration promised by the customer has been received by the entity and is non-refundable; or

• the contract has been terminated and the consideration received from the customer is non-refundable.

An entity shall recognize the consideration received from a customer as a liability until one of the events mentioned above occurs or until the criteria mentioned above (all conditions to be a valid contract) are subsequently met.

Depending on the facts and circumstances relating to the contract, the liability recognized represents the entity’s obligation to either transfer goods or services in the future or refund the consideration received. In either case, the liability shall be measured at the amount of consideration received from the customer.

Step 2: Identify performance obligations

A performance obligation is a promise to transfer to a customer:

• a good or service (or bundle of goods or services) that is distinct; or

• a series of goods or services that are substantially the same and are transferred in the same way.

If a promise to transfer a good or service is not distinct from other goods and services in a contract, then the goods or services are combined into a single performance obligation.

A good or service is distinct if both of the following criteria are met:

1. The customer can benefit from the good or service on its own or when combined with the customer's available resources; and

2. The promise to transfer the good or service is separately identifiable from other goods or services in the contract.

A transfer of a good or service is separately identifiable if the good or service:

• Is not integrated with other goods or services in the contract;

• Does not modify or customize another good or service in the contract; or

• Does not depend on or relate to other goods or services promised in the contract.

Example to identify performance obligations:

XYZ Pvt. Ltd. is in the business of construction. It enters into a contract with a customer for the construction of a specific building. The goods and services to be provided in the contract include procurement, construction, piping, wiring, installation of equipment and finishing.

Although the goods and services provided by the contractor are capable of being distinct, they are not distinct in this contract because the goods and services cannot be separately identified from the promise to construct the building. XYZ Pvt. Ltd. will integrate the goods and services into the unit, so all the goods and services are accounted for as a single performance obligation.

Step 3: Determine the Transaction Price

The transaction price is the amount of consideration to which an entity is entitled in exchange for transferring goods or services.

The transfer price does not include amounts collected for third parties (i.e. sales taxes or VAT).

The effects of the following must be considered when determining the transaction price:

• The time value of money (the concept of discounting) has to be considered if a significant financing component in the contract exists. The time value of money does not need to be considered if the length of the contract is less than one year.

• In the situation where non-cash consideration is received, the Fair Value of any non-cash consideration received is the transaction piece.

• Estimates of variable consideration (“Expected Value” or “Most likely amount” method depending on the facts of the case).

• Consideration payable to the customer - Consideration payable to the customer is treated as a reduction in the transaction price unless the payment is for goods or services received from the customer).

Step 4: Allocate Transaction Price

The transaction price is allocated to all separate performance obligations in proportion to the stand-alone selling price of the goods or services.

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 stand-alone selling price is the observable price of a good or service when it is sold separately.

The stand-alone selling price should be estimated if it is not observable.

The allocation is made at the beginning of the contract and is not adjusted for subsequent changes in the stand-alone selling prices of the goods or services.

Step 5: Recognize Revenue

Recognize revenue when (or as) a performance obligation is satisfied by transferring a promised good or service (an asset) to the customer.

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

The entity must determine whether the performance obligation will be satisfied over time or at a point in time.

A performance obligation is satisfied over time if one of the following criteria is met:

• The customer receives and consumes the benefits of the entity's performance as the entity performs (e.g. service contracts, such as a cleaning service or a monthly payroll processing service).

• The entity's performance creates or enhances an asset that the customer controls as the asset is created or enhanced (e.g. a work-in-process asset).

• The entity's performance does not create an asset with an alternative use to the entity (seller) and the entity has an enforceable right to payment for performance completed to date.

Revenue is recognized over time by measuring progress towards complete satisfaction of the performance obligation. Output methods and input methods can be used to measure progress towards completion.

A performance obligation that is not satisfied over time is satisfied at a point in time.

Revenue should be recognized at the point in time when the customer obtains control of the asset.

Indicators of the transfer of control include:

• the customer has an obligation to pay for an asset;

• the customer has legal title to the asset ;

• the entity has transferred physical possession of the asset;

• the customer has the significant risks and rewards of ownership;

• the customer has accepted the asset.

Conclusion:

Ind AS 115 deals with recognition or revenue arising from the sale of goods and services.

The thought process of revenue recognition, in summary, is to:

• Identify a contract with a customer.

• Then determine different performance obligations of the seller (service provider) in the contract.

• Then determine and allocate the transaction price to each performance obligation.

• Then for each performance obligation determine if they will be satisfied over time or at a point in time and then recognize revenue accordingly for each performance obligation.

Ind AS 115 is significantly different from the “Accounting Standard 9 – Revenue Recognition”.

This article has been published in the Chartered Accountant Study Circle ("CASC") Bulletin.