Ind AS 115: Revenue from

Contracts with Customers

Corresponding Accounting StandardsAS 7: Construction ContractsAS 9: Revenue Recognition

Implement Ind AS 115

Overview to Ind AS 115 Revenue from customers

Indian Accounting Standard 115, “Revenue from Customers” is the converged version of Ind AS 11, ”Construction Contracts” and Ind AS 18, “Revenue” which is on the lines of a similar convergence by the IASB (International Accounting Standard Board) of the IAS 11 and IAS 18.

While under the former regime of Accounting Standards, the scope of Revenue was covered by 2 ASs, viz. AS 9, “Revenue Recognition” and AS 7, “Construction Contracts”, the Ind AS lays down consolidated guidelines for accounting, measurement and recognition for revenue from both Construction Contracts and other businesses (except those specifically excluded through Para 5 Ind AS 115).

Ind AS 115 contains principles for determination of the principles of measurement of revenue and the timing of revenue recognition.

The standard would significantly change how an entity recognizes its revenue from customers and will also result in a significant increase in the volume of disclosures related to revenue.

Applicability of Ind AS 115 and its deferment

The Ind AS 115, “Revenue from Customers”, is a carve out of the IFRS 15, “Revenue from Contract with Customers” issued by the IASB.

Technology and telecom companies are largely going be impacted with this standard, i.e. mainly those companies which currently bundle their services together. Due to the requirement of the 5 step model, revenue recognition will now be more scientific and transparent.

Although, the MCA notification (on applicability of Ind AS to various class of companies) does not rule out its implementation as per the roadmap, the IFRS 15 in itself is set to be implemented from 2017 onwards only. Also, as per a recent article published in the Economic Times, India is likely to defer the adoption of Ind AS 115 as more consultation is needed with the industry to clarify the requirements and to give examples to help implementation.

In such a situation India may adopt the Ind AS 18, “Revenue” and Ind AS 11, “Construction Contracts” for the interim period.

Ind AS 17 •Lease contracts

Ind AS 104 •Insurance Contracts

Ind AS 109, 110, 111, 27 & 28

• Financial Instruments and other contractual rights/obligations

Others •Non monetary exchanges between similar entities

Scope of Ind AS 115

Applicable to all contracts with customers (including those with non monetary asset), except:

Not c

over

ed

Definitions

Some of the key terms defined in this standard are:1. 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).

2. Contract LiabilityAn entity’s obligation to transfer goods or services to a customer for which the entity has received or is entitled to receive consideration from the customer.

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

5. 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.

6. 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.

Revenue Recognition and Measurement under Ind AS 115

Ind AS 115, “Revenue from Customers”, lays down a five step model approach to the measurement and recognition of revenue from customers. The five step model requires combining/separating contracts with customers, identifying the distinct components in the contracts and recognizing revenue as per the separately allocated transaction price and on fulfillment of certain conditions.

AS 9, “Revenue” which covered the accounting, measurement etc. of revenue from sale of goods, rendering of services and interest, royalties and dividend incomes required fulfillment of certain conditions for an entity to be able recognize revenue from such transactions.While AS 7 did cover the contract based recognition approach, it based the recognition on percentage of completion while Ind AS 115 requires identification of the distinct components of the goods or services in a contract and recognition of revenue on satisfaction of the conditions laid under the fifth step for not only construction contracts but all revenue from all other nature of businesses.

The following slides cover in detail the five step model and thus, the recognition and measurement of revenue.

Identify the contract with a

customer.

Identify the separate performance

obligations in the contract.

Determine the transaction price.

Allocate the transaction price to the separate

performance obligations.

Recognize revenue when (or as) each

performance obligation is satisfied.

The five step approach for

recognition of revenue

The Ind AS approach to Revenue from CustomersRevenue recognition as per Ind AS 115 has been described hereunder with the help of an example in order to give a bird’s eye view of the Ind AS approach to Revenue from Customers.

X enters into a 12-month telecom plan with Airtel . The terms of the plan are as follows: 1. X monthly fixed fee is INR 5,000. 2. X receives a free handset at the inception of the plan. Airtel sells the same handsets for INR 25,000 and the same monthly prepayment plans without handset for INR 4,000/month. How should Airtel recognize the revenues as per Ind AS 115?

Revenue under Ind AS 115 Step 1. Identify the contract first.

Step 2. Identify all performance obligation. Here, being delivery of handset and service.Step 3. The transaction price is INR 60,000 (being 5,000 X 12 months).

Step 4. Allocate that transaction price of INR 60,000 to individual performance obligations.

Step 5. Recognize the revenue when Airtel satisfies the performance obligations.

Performance obligation Stand-alone selling price

% on total Revenue(Relative Selling Price = 60,000*%)

Handset 25,000 34% 20,500Network services 48,000 (=4000*12) 66% 39,500

Total 73,000 100.00% 60,000

Identify the contract with a customer.Step 1

The initial step in the five step model. It requires identifying a contract with the customer/s where a contract with the prescribed attributes is present.It further talks about combining various contracts with the same customer if the contracts are negotiated as a single performance obligation with a single commercial objective and/or inter dependent considerations.

Who is a customer???

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

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

INCOME - Increases in economic benefits in the form of inflows or enhancements of assets or decreases of liabilities that result in an increase in equity (except capital contributions).

Contract - An agreement between two or more parties that creates enforceable rights and obligations. It may be written, oral or implied by the business’ customary practices.

Necessary attributes of a contract as per Ind AS 115:

The parties have approved the contract and

intend to perform their respective

obligations.

Each party’s rights regarding the

goods or services to be transferred can be identified.

Payment terms can be identified.

Contract has commercial

substance i.e. the risk, timing or amount of the

entity’s future cash flows are expected

to change.

It is probable that the entity will

collect the consideration to which it will be

entitled in exchange for goods

or services transferred.

Whether all conditions are satisfied?

Yes No

Account for any consideration received from customer as a liability until the termination or fulfillment of the contract.

Follow subsequent steps for recognition of revenue as per the five step model only.

Contract Combination

2 or more contracts negotiated as a package.E.g. audit of individual entities of a group company.

No

Consideration of one contract depends on another.

No

Goods or services in a contract are a single performance obligation as per Step No. 2.

Com

bine

Con

trac

ts

Combination of Contract is not possible. Thus treat contract as individual contract.

Yes

Yes

YesNo

Contract Modification

Addition of distinct

goods or services

Additional consideratio

n=

Standalone price of

additional goods or services

Contract Modification

Treat modification as a separate contract

YesNo

Condition 1 Condition 2

Treat modification as described on next slide

Only condition 1 is satisfied

Existing contract stands cancelled and treat as

new contract

Then, consideration=

additional consideration+

Unrecognized revenue

Follow steps 1 to 5

Modification not treated as a separate contract

Addition of distinct goods or services are distinctly identifiable only for some part

Treat in any suitable manner

None of the condition is satisfied

Treat as a single unsatisfied performance

obligation (Step 2)

At contract inception, an entity is required to identify the separate performance obligations in a contract. A Performance Obligation is 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(b) a series of distinct goods or services that are substantially the same and that have the same pattern of

transfer to the customer which is characterized by any one of the conditions of transfer of control over time.

Promise may be implicit, explicit or implied through the business’ customary business practice.

The promise to transfer the distinct goods or service excludes goods or services that are to be used as an input in producing other goods or services specified by the customer.

For instance, in the example taken in the beginning of the 5 step model, the separate performance obligations are service by Airtel (falling under part (b) of the above definition of performance obligation) and transfer of handset mobile (falling under part (a) of the above definition of performance obligation) to the customer.

Identify the separate performance obligations in the contract.Step 2

Distinct goods or servicesCan be used

independently or with other readily available

resources

Promise to transfer is separately identifiable from other promises

As per Ind AS 115, the transaction price (for a contract with a customer) 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.Thus, amounts received as an agent is transaction price only to the extent of the agent’s own share of consideration.

Determine the transaction price.Step 3

TRANSACTION PRICE

Fixed cash consideration

Variable consideration

Financing component

Non cash consideration

Payable to a customer

Normally shown as a reduction in transaction price

Examples of variable consideration includes performance discounts, bonuses, refund rights and penalties as well. Variable consideration is included in the determination of the transaction price only if it is highly probable that there will not be a significant revenue reversal.Factors (not exhaustive) that indicate high probability of revenue reversal

Uncertainty over long period of time

Variable Consideration

Key effects

• Entities must recognize ‘minimum amount’ that is highly probable of not reversing.• It will lead to early recognition of revenue unlike under the current GAAP where such consideration is

recognized on realization only.• The variable consideration recognized should be reassessed at the end of each reporting period and

necessary adjustments should be made.

Expecte

d Value

Metho

d

• Sum of probability weighted amounts in a range of possible outcomes.

• Appropriate for large no. of similar contracts.

• E.g. If the probability of receiving a variable consideration of Rs 1,00,000/- is 30% while that of Rs 50,000 is 70%. Then, estimated variable consideration=(100000*0.3)+(50000*0.7)=65,000

Most

Likely Amount

Method

• A single most likely amount in a range of possible outcomes.

• E.g. In a contract which entitles the entity to a performance bonus of rupees, say, 10,000 only on fulfillment of all the performance obligations, the management decide, basis its past experience and records, if it will be entitled to the bonus.In case it isYES – Estimated Variable consideration = Rs 10,000NO - Estimated Variable consideration = Nil

Methods for Calculating Variable Consideration

Miscellaneous

• Both the method requires management consideration of historical, current and forecast information.

• Any 1 method to be consistently applied.

Time Value of Money

While determining the transaction price, the fact that a significant financing component exists, regardless of the fact that it is validated explicitly by a written agreement or not, should be considered.

However, an entity should not recognize a financing component, if any of the following situation is satisfied:-1. Advance is paid by the customer but the transfer of the goods and/or services is at the discretion of

the customer, or2. Difference between the consideration defined and the cash selling price exists due to some other

specified reason. E.g. If difference exists due to an escalation clause or an amount levied on non abidance of a particular clause, etc.

The process of identifying the financing component has been elaborated subsequently:

FINANCING COMPONENT

Interest Expense when customer pays in advance

Rate between the customer and the entity, had the transaction been only a financing transaction.

Time value of money to be considered only if time gap is more than 1 year.

Proximity of the financing component identified with the prevailing interest rates in market

Expected time gap between transfer of goods/services and payment

Existence of difference between defined consideration and cash selling price

Evaluation of Existence

To be disclosed separately from other interest incomes/expenses

Interest component to be calculated using the discounting technique

Factors affecting discount rate

Credit characteristics of person receiving finance. E.g. Credit ratings

The fact that the financing transaction is secured or unsecured.

Interest Income when customer pays at a later date

To be fixed at contract

inception itself

Non - Cash Consideration

A customer may pay or promise to pay the entity, in exchange of its goods or services, consideration in a form other than cash. Such consideration should be measured at fair value of the asset being transferred or promised to being transferred by the customer.

However, there may be a situation where such fair value is not available, the entity should measure such consideration at the stand alone selling price of the goods or services of the entity transferred to the customer.

Supply of inputs by customerA customer may supply raw materials, labor, etc. to the entity for being used in the process of manufacture of goods or rendering of services. In such a case, the inputs shall be valued as above.

Allocate the transaction price to the separate performance obligations.Step 4

• In ratio of the ‘Stand-alone Selling Prices’ (SASP)

Allocation of Transaction Price

As per Para 31 of Ind AS 115, an entity shall recognize revenue when (or as) the entity satisfies a performance obligation by transferring a promised asset to a customer. Further, an asset is transferred when (or as) the customer obtains control of that asset. The five step model requires determining, at the very inception of the contract, whether the performance obligation will be satisfied “over time” or “in time”. Such identification and classification has been covered in detail in the following slides.

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

Under Ind AS 115, revenue is recognised when a customer obtains control of a good or service, while under present Indian GAAP, 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. Transfer of control is neither same as transfer of risks and rewards nor similar to the culmination of an earnings process as understood today.

CA Eish Taneja, in a presentation at the Assocham, rightly described the subtleness of the difference between transfer of control vis-a-vis transfer of risk and reward as, “…..can sometimes be subtle and at other times be stark requiring a detailed understanding of the accounting standard and customer contractual arrangements. A change of mindset about revenue recognition might be needed to migrate from an evaluation of “Risk and rewards” under existing guidance to an evaluation of “transfer of control” under the new standard……”

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

Indicators of customer obtaining control of an asset

The major underlying principle over transfer of control is that the customer should obtain the ability to direct the use of and take substantially all the benefits from the asset. It may further be appropriate to explain here that “goods and services are assets, even if momentarily, when they are received and used”. The below mentioned list of indicators are the key ones which an entity shall evaluate while evaluating the transfer of control. An entity may also consider other relevant factors.

Indicators Circumstances when it shall deemed to be transfer

Transfer of significant risk and rewards of ownership

When another separate performance obligation, which is in addition to the performance obligation to transfer the asset still remains to be complete.

Customer has accepted the asset which ordinarily should be non – repudiable (implied or explicit, as the situation may require)

No such exception

Legal title to asset When the entity retains the legal title solely to seek protection of payment.

Transfer of physical possession of the asset In arrangements, such as a bill and hold arrangement, where physical possession of the asset is not transferred but goods are kept in the custody of the entity.

Present right to payment for asset No such exception

Customer receives and consumes benefit as service is performed.E.g. cleaning service

No

Performance creates/enhances an asset customer controlsE.g. construction of house on customer land

No

Performance does not create an asset with alternative use and entity has right to payment for work completed to date.

For details read on.

Transfer of Control Over Time and at a Point In Time

Ove

r Tim

e Point in Tim

eYes

Yes

YesNo

Contractual restrictions • Substantive, if customer could enforce its right to direct the specific asset for another use.

Practical limitations • Exists if entity would incur significant losses if the asset is directed for another use.

Assessing whether entity’s performance creates an asset with an alternative use

Yes

No

Asset with alternative use is not created

Asset with alternative use is created

and/or

Recognizing revenue from performance obligations satisfied Over Time

The Application Guidance, which forms an integral part of the standard, prescribes two methods for measuring the progress towards complete satisfaction of a performance obligation satisfied over time, namely,a) Output method andb) Input methodThe methods may be selected depending upon the nature of goods or service sold by the entity.

Considering the subjectivity of the methods, these have not been discussed here and may be referred to, from the Ind AS 115 directly.

As promised earlier, this presentation is in continuation to my endeavor to disseminate, to the least, what I posses on Ind AS to my happy readers.

I hope this be able to stand upto their expectations and serve their purpose.

Stay tuned for more.

Till then, Happy Reading to you !!

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Prepared by: Nitish Aggarwal

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