IND AS 115 | Summary | The main aim of IND AS 115 is to recognize revenue in a way that shows the transfer of goods/services promised to customers in an amount reflecting the expected consideration in return for those goods or services.
It seems understandable and very easy at first sight, and it truly is in many cases. So why is IND AS 115 so extensive?
Well, because many situations are not so simple and have complex treatment in accounting and entities recognize revenues differently in these cases, for example:
- Buy 5+get 3 free;
- Buy monthly telecommunication prepaid plan + get handset for free;
- Earn referring points and cash them out/receive free goods later on;
- Get bonuses for delivery on time; etc.
To make it more systematic, IND AS 115 requires application of 5 step model for revenue recognition.
The 5 steps are mentioned in the following picture:
Let’s discuss them a one by one.
IND AS 115 | Step 1: Identify the contract with the customer
A contract is an agreement between 2 parties that creates enforceable rights and obligations
You need to apply Ind AS 15 to all contracts that have the following 5 characteristics :
- Parties to the contract has approved the contract and they are committed to perform that;
- Each party’s rights to the goods/services transferred are identifiable;
- The payment terms are identifiable;
- The contract has a clear commercial substance; and
- It is highly probable that an entity will able to collect the consideration – here, you are to evaluate the customer’s ability and intention to pay for goods and services.
So, if the contract is not meeting all 5 criteria, then you don’t need to apply Ind AS 15, but some other standard might be applicable to that contract.
Therefore, be careful about intra-group transactions, as they often lack a commercial substance (as these companies often transfer inventories and other items at prices different than the market).
IND AS 115 provides guidance about contract combinations and contract modifications, too.
Contract combination happens when you need to account for two or more contract as for 1 contract and not separately. IND AS 115 sets the criteria for combined accounting.
Contract modification is the change in the contract’s scope, price or both. In other words, when you add certain goods or services, or you provide some additional discount, you are effectively dealing with the contract modification.
IND AS 115 sets different accounting methods for individual contract modification, depending on certain conditions.
IND AS 115 | Step 2: Identify the performance obligations in the contract
Performance obligation is any good or service that contract promises to transfer to the customer.
It can be either (IND AS 115 )
- A single good or service, or their bundle that is distinct; or
- A series of distinct goods or services that are substantially the same and have the same pattern of transfer.
An essential characteristic of a performance obligation is the word “distinct”. Simply said, distinct means separable, or separately identifiable, and Ind AS 115 sets criteria that you must assess in order to determine whether the performance obligation is distinct or not.
Let me say that this is extremely important and you must do it right.
The reason is that in further steps, you will account for distinct performance obligations and their revenues separately, in line with their allocated transaction price, and if you fail in the correct identification of distinct performance obligations, then the whole contract accounting will be wrong.
Let me also add that the performance obligations can be both explicit (e.g. written in the contract) and implicit (e.g. implied by some customary practices).
Also, if there’s no transfer to customer, then there’s no performance obligation. For example, imagine you construct a building for your client. Before you actually start, you build a small mobile toilet for your workers. As this will not be delivered to your customer, it is not a separate performance obligation.
IND AS 115 | Step 3: Determine the transaction price
The transaction price is the amount of consideration than 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
That’s the definition from the standard and in other words, it’s what you expect to receive from your customer in return for your supplies.
Attention – it’s NOT always the price set in the contract. It is your expectation of what you receive.
It means that you need to estimate the transaction price.
How?
First, you need to take the price stated in the contract as some basis (if applicable).
Then, you need to take some items into account, such as:
- Variable consideration – are there some bonuses or discounts, for example, performance bonus?
- Constraining estimates in variable consideration – you should include variable consideration (e.g. bonus) in the transaction price only when it’s highly probable that you can keep it (this is a big simplification);
- Significant financing component – if your clients will pay you with delay, do the payments reflect the time value of money?
- Non-cash consideration – do you receive some non-cash items from your customer in return for your goods or services?
- Consideration payable to a customer – do you provide some vouchers or coupons to your customers?
- And other factors.
IND AS 115 | Step 4: Allocate the transaction price to the performance obligations
Once you have identified the contract‘s performance obligations and determined the transaction price, you need to split the transaction price and allocate it to the individual performance obligations.
The general rule is to do it based on their relative stand-alone selling prices, but there are 2 exceptions when you allocate in a different way:
- When allocating discounts, and
- When allocating considerations with variable amounts.
A stand-alone selling price is a price at which an entity would sell a promised good or a service separately to the customer (not in the bundle).
The best way to determine a stand-alone selling price is simply to take observable selling prices and if these are not available, then you need to estimate them. Ind AS 15 suggests a few methods for estimating stand-alone selling prices, such as adjusted market assessment approach, etc.
IND AS 115 | Step 5 : Recognize revenue when (or as) the entity satisfies a performance obligation
A performance obligation is satisfied (and revenue is recognized) when a promised good or service is transferred to a customer. This happens when control is passed.
A performance obligation can be satisfied either:
- Over time – in this case, control is passed to the customer over some period of time (e.g. contract term); or
- At the point of time – in this case, control is retained by the supplier until it is transferred at some moment.
Ind AS 15 sets a few criteria when you should recognize revenue over time. In all other cases, revenue is recognized at the point of time.
Except for these 5 steps, Ind AS 15 arranges a few other areas, such as…
IND AS 115 | Contract costs
IND AS 115 provides guidance about two types of costs related to the contract:
Costs to obtain a contract
Those are the incremental costs to obtain a contract. In other words, these costs would not have been incurred without an effort to obtain a contract – for example, legal fees, sales commissions and similar. These costs are not expensed in profit or loss, but instead, they are recognized as an asset if they are expected to be recovered (the exception is the contract costs related to the contracts for less than 12 months).
Costs to fulfill a contract
If these costs are within the scope of Ind AS 2, Ind AS 16, Ind AS 38, then you should treat them in line with the appropriate standard. If not, then you should capitalize them only if certain criteria are met.
Source: ICAI, Internet
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