3.Ind AS 115 - Detailed notes on revised Revenue standard Ind AS 115 PDF

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Detailed notes on revised Revenue standard Ind AS 115...

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3 IND AS 115 REVENUE FROM CONTRACTS WITH CUSTOMERS LEARNING OUTCOMES After studying this chapter, you will be able to:  Appreciate the scope and definition of the standard.  Identify the contract.  Comprehend the criteria for revenue recognition.  Gain knowledge on accounting treatment of various aspects like combination of contracts, contract modifications etc.  Identify performance obligations and when the performance obligation is satisfied.  Determine the transaction price and allocate the performance obligation to transaction price.  Allocate discount to various performance obligations in determining their transaction price.  Account for the changes in the transaction price.  Account for variable considerations while determining the transaction price.  Deal with contract costs.  Comply with the Presentation and disclosure requirements of the standard.

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CHAPTER OVERVIEW Ind AS 115 Revenue from contracts with customers

Scope

Definitions

Recognition

Criteria for recognizing a contract

Contract term Combining contracts

Contract modifications Consignment Arrangements Principal vs agent consideration

Step 2 – Identifying performance obligation

Promises in contracts with customers

Distinct goods or services

Long term arrangements

Presentation and disclosure

Incremental costs v/s Fulfilment costs

Five step model

Step 1 – Identifying the contract

Contract costs

Step 3 – Determination of transaction price

Variable consideration – constraints in estimating variable consideration

Step 4 – Allocation of transaction price to performance obligation Methods of allocating transaction price Allocation of a discount

Existence of significant financing component Non cash consideration Consideration payable to a customer

Nonrefundable upfront fees

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Allocation of variable consideration, discount

Changes in transaction price

Step 5 – Satisfaction of performance obligation

Performance obligations satisfied over time Performance obligations satisfied at a point in time Measuring progress towards complete satisfaction of a performance obligation

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This standard establishes principles to report useful information about the nature, amount, timing and uncertainty of revenue and cash flows arising from a contract with a customer. The core principle is that an entity shall recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard specifies the accounting for an individual contract with a customer. However, as a practical expedient, an entity may apply this Standard to a portfolio of contracts (or performance obligations) with similar characteristics if the entity reasonably expects that the effects of applying the Standard to the portfolio would not differ materially from applying this Standard to the individual contracts (or performance obligations) within that portfolio.

1.

SCOPE

Ind AS 115 applies to all contracts with customers to provide goods or services that are outputs of the entity’s ordinary course of business in exchange for consideration, unless specifically excluded from the scope of the new guidance, as described below. An entity shall apply this Standard to all contracts with customers, except the following: (a) lease contracts within the scope of Ind AS 116, Leases; (b) insurance contracts within the scope of Ind AS 104, Insurance Contracts (c) financial instruments and other contractual rights or obligations within the scope of 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 (d) non-monetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers. For example, this Standard would not apply to a contract between two oil companies that agree to an exchange of oil to fulfil demand from their customers in different specified locations on a timely basis. This standard is applicable only if the counterparty to the contract is a 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.

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FINANCIAL REPORTING

A contract with a customer may be partially within the scope of Ind AS 115 and partially within the scope of other Ind AS. In such cases, the following steps should be followed to identify how it should be split between Ind AS 115 and other Ind AS: (i)

If the other Ind AS specify how to separate and/or measure a portion of the contract, then that guidance should be applied first. The amounts measured under other Ind AS should be excluded from the transaction price that is allocated to performance obligations under Ind AS 115.

(ii) If the other Ind AS do not stipulate how to separate and/or measure a portion of the contract, then Ind AS 115 would be used to separate and/or measure that portion of the contract (refer discussion relating to Step 4 - Allocation of transaction price to performance obligation ). Ind AS 115 also specifies the accounting for the incremental costs of obtaining a contract with a customer and for the costs incurred to fulfil a contract with a customer if those costs are not within the scope of another Standard (see section related to Contract Costs). An entity shall apply those paragraphs only to the costs incurred that relate to a contract with a customer (or part of that contract) that is within the scope of this Standard.

2.

DEFINITIONS

Contract

An agreement between two or more parties that creates enforceable rights and obligations.

Contract asset

An entity’s right to consideration in exchange for goods or services that the entity has transferred to a customer when that right is conditioned on something other than the passage of time (for example, the entity’s future performance).

Contract liability

An entity’s obligation to transfer goods or services to a customer for which the entity has received consideration (or the amount is due) from the customer.

Customer

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.

Income

Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in an increase in equity, other than those relating to contributions from equity participants.

Performance obligation

A promise in a contract with a customer to transfer to the customer either: (a) a good or service (or a bundle of goods or services) that is distinct; or

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(b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer. Revenue

Income arising in the course of an entity’s ordinary activities.

Stand-alone selling price (of a good or service)

The price at which an entity would sell a promised good or service separately to a customer.

Transaction price (for a contract with a customer)

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.

3.

OVERVIEW

After more than a decade of work, the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) had published their largely converged standards on revenue recognition in May, 2014. The IASB issued IFRS 15 Revenue from Contracts with Customers and FASB issued ASU 2014-09 with the same name. In convergence with IFRS, the Ministry of Corporate Affairs (MCA) issued Ind AS 115, Revenue from Contracts with Customers vide its notification dated 28th March, 2018. Ind AS 115 supersedes and replaces Ind AS 11 and Ind AS 18. Ind AS 115 is based on a core principle that requires an entity to recognise revenue: (a) In a manner that depicts the transfer of goods or services to customers (b) At an amount that reflects the consideration the entity expects to be entitled to in exchange for those goods or services. To achieve the core principle, an entity should apply the following five-step model: Step 1: Identify the contract with the customer. Step 2: Identify the performance obligations in the contract. Step 3: Determine the transaction price. Step 4: Allocate the transaction price to the performance obligations in the contract. Step 5: Recognize revenue when (or as) the entity satisfies its performance obligations.

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Identify the contract(s) with a customer Identify the performance obligations

Determine the transaction price Allocate the transaction price to the performance obligations

Recognise revenue when or as an entity satisfies performance obligations Each of these steps, and some other related guidance, is discussed in details below.

4.

TRANSITION

Ind AS 115 is effective for annual reporting periods beginning on or after 1 st April, 2018. Entities are required to apply the new revenue standard using either of the following two approaches: (a) Full retrospective approach: retrospectively to each prior period presented in accordance with Ind AS 8, subject to some practical expedients mentioned in the standard or (b) Modified retrospective approach: retrospectively with the cumulative effect of initial application recognised at the date of initial application When applying the full retrospective method, an entity shall restate all prior periods presented in accordance with Ind AS 8. This results in comparative statements in which all periods are presented as if Ind AS 115 had been in effect since the beginning of the earliest period presented. When applying modified retrospective approach, an entity does not restate prior periods presented and the cumulative effect of initial application is recognised in the opening retained earnings of the first year of application of Ind AS 115.

5.

STEP 1: IDENTIFYING THE CONTRACT

As the guidance in Ind AS 115 applies only to contracts with customers, the first step in the model is to identify such contracts. A contract is an agreement between two or more parties that creates enforceable rights and obligations. Enforceability of the rights and obligations in a contract is a matter of law. Contracts can be written, oral, or implied by an entity’s customary business practices. The practices and processes

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for establishing contracts with customers vary across legal jurisdictions, industries, and entities. In addition, they may vary within an entity (for example, they may depend on the class of customer or the nature of the promised goods or services). An entity shall consider those practices and processes in determining whether and when an agreement with a customer creates enforceable rights and obligations. The guidance in Ind AS makes it clear that the rights and obligations in a contract must be “enforceable” in order for an entity to apply the five-step revenue model. Enforceability is a matter of law, so an entity needs to consider the local relevant legal environment to make that determination. That said, while the contract must be legally enforceable, oral or implied promises may give rise to performance obligations in the contract.

5.1 Criteria for recognizing a contract Step 1 serves as a ‘gateway’ through which an entity must pass before proceeding to the later steps of the model. In other words, if at the inception of an arrangement, an entity concludes that the criteria below are not met, it should not apply Steps 2 through 5 of the model until it determines that the Step 1 criteria are subsequently met. When a contract meets the five criteria and ‘passes’ Step 1, the entity will not reassess the Step 1 criteria unless there is an indication of a significant change in facts and circumstances. An accounting contract exists only when an arrangement with a customer meets each of the following five criteria: (a) The parties have approved (in writing, orally or in accordance with other customary business practices) the contract and are committed to perform their contractual 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 substantially all of the consideration to which it expects to be entitled. If the arrangement does not meet the five criteria at inception, an accounting contract, for purposes of applying Ind AS 115, does not exist, and the entity should continue to reassess whether the five criteria are subsequently met. For example, if a customer’s ability to pay the consideration deteriorates significantly, an entity would reassess whether it is probable that the entity will collect the consideration to which the entity will be entitled in exchange for the remaining goods or services that will be transferred to the customer. A contract may not pass Step 1, but the entity may still transfer goods or services to the customer and receive non-refundable consideration in exchange for those goods or services. In that circumstance, the entity cannot recognise revenue for the non-refundable consideration received

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until either the Step 1 criteria are subsequently met, or one of the events outlined below has occurred: (a) 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 (b) The contract has been terminated, and the consideration received from the customer is nonrefundable. Continue to assess the contract to determine if the Step 1 criteria are met.

Consider if the contract meets each of the five criteria to pass Step 1: Have the parties approved the contract?

No

Yes Can the entity identify each party's rights regarding the goods/services to be transferred?

No

Yes Can the entity identify the payment terms for the goods/services to be transferred? Yes Does the contract have commercial substance?

No

No

Yes Is it probable that the entity will collect substantially all of the consideration to which it will be entitled in exchange for the goods/services that will be transferred to the customer?

No

Recognise consideration received as a liability until each of the five criteria in Step 1 are met or one of the following occurs: 1. entity has no remaining performance obligations and substantially all consideration has been received and is nonrefundable. 2. contract is terminated and consideration is non-refundable

Yes Proceed to Step 2 and only reassess the Step 1 criteria if there is an indication of a significant change in facts and circumstances. Each of the criteria mentioned above are discussed in more detail below:

5.1.1 Criteria 1: The parties have approved the contract and are committed to perform To pass Step 1, the parties must approve the contract. This approval may be written, oral, or implied,

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as long as the parties intend to be bound by the terms and conditions of the contract. The parties should also be committed to performing their respective obligations under the contract. This does not mean that the parties need to be committed to fulfil all of their respective rights and obligations in order for this criterion to be met. For example, an entity may include a requirement in a contract for the customer to purchase a minimum quantity of goods each month, but the entity may have a history of not enforcing the requirement. In this example, the contract approval criterion can still be satisfied if evidence supports that the customer and the entity are both substantially committed to the contract.

5.1.2 Criteria 2: The entity can identify each party’s rights An entity must be able to identify its rights, as well as the rights of all other parties to the contract. An entity cannot assess the transfer of goods or services if it cannot identify each party’s rights regarding those goods or services.

5.1.3 Criteria 3: The entity can identify the payment terms for the goods or services An entity must also be able to identify the payment terms for the promised goods or services within the contract. The entity cannot determine how much it will receive in exchange for the promised goods or services (the “transaction price” in Step 3 of the model) if it cannot identify the contractual payment terms.

5.1.4 Criteria 4: The contract has commercial substance A contract has commercial substance if the risk, timing, or amount of the entity’s cash flows is expected to change as a result of the contract. In other words, the contract must have economic consequences. This criterion was added to prevent entities from transferring goods or services back and forth to each other for little or no consideration to artificially inflate their revenue. This criterion is applicable for both monetary and nonmonetary transactions, because without commercial substance, it is questionable whether an entity has entered into a transaction that has economic consequences.

5.1.5. Criteria 5: It is probable the entity will collect substantially all of the consideration To pass Step 1, an entity must determine that it is probable that it will collect substantially all of the consideration to which it will be entitled under the contract in exchange for goods or services that it will transfer to the customer. This criterion is also referred to as the ‘collectability assessment’. In determining whether collection is probable, the entity considers the customer’s ability and intention to pay when amounts are due. In making the determination of customer’s ability to pay, the credit risk was a...