Ind as 115

Ind AS 115 "Revenue from Contracts with Customers" - A brief points

1. “   CMA Raman Khanna [email protected]

2. MCA notified Ind AS 115 – “Revenue from Contracts with Customers” on 28 th March 2018 Ind AS 115 is effective from 01-April-2018 Ind AS 115 is based on IFRS 15. IFRS 15 is effective from 01 st January 2018 In AS 11 – Construction Contracts Ind AS 18 – Revenue Guidance Note of ICAI on Accounting for Real Estate Transactions for Ind AS entities In AS 16 – Property, Plant and Equipment Replaces Modifies

3. Conceptual change - transfer of control vs risks and rewards 1) Under Ind AS 115, Revenue is recognized when a customer obtains control of a good or service. Under existing Ind AS, Revenue is recognized when there is a transfer of risk and rewards 2) A customer obtains control when it has the ability to direct the use of and obtain the benefits from the good or service 3) Entities will be required to apply the new guidance to determine whether revenue should be recognized ‘over time’ or ‘at a point in time’. 4) Transfer of control is neither the same as transfer of risks and rewards nor similar to the culmination of an earnings process as understood today.

4. lease contracts under Ind AS 17 – Leases (b) insurance contracts under Ind AS 104 - Insurance Contracts (d) financial instruments & other contractual rights /obligations under: Ind AS 109 - Financial Instruments , Ind AS 110 - Consolidated Financial Statements , Ind AS 111 - Joint Arrangements , Ind AS 27 - Separate Financial Statements Ind AS 28 - Investments in Associates and Joint Ventures ; (c) non-monetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers. SCOPE OF IND AS 115 An entity shall apply this Standard to all contracts with customers, except following:

5. CORE PRINCIPLE An entity shall recognize 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. Some situations where different approaches are followed in recognizing revenue e.g.: Buy 1 + get 1 free; Buy monthly prepaid plan + get handset free ; Earn loyalty reward points and cash them out / receive free goods later on ; Cash back offers on purchases through Paytm , Amazon etc.; Get bonuses for delivery on time / before due date; etc .

6. 5 Step Model for recognition of Revenue 1 2 3 4 5

7. Step-2 : Identify separate “PERFORMANCE OBLIGATION” in contract An entity shall assess the goods or services promised in a contract and identify as a performance obligation each promise to transfer to the customer either: a good or service (or a bundle of goods or services) that is distinct; or 2) a series of distinct goods or services that are substantially the similar and have the same pattern of transfer to the customer Promise may be implicit , explicit or implied through the entity’s customary business practice .

8. If a promised good / service is not distinct , an entity shall combine that good or service with other promised goods or services . In some cases, it would result in for all the goods or services promised in a contract as a single performance obligation. (a) Customer can benefit from the good or service either on its own or together with other resources that are readily available to him ( ie the good or service is capable of being distinct); and (b) Entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract ( ie the good or service is distinct within the context of the contract). A good or service promised is distinct if both of the both the criteria are met : Satisfaction of performance obligations An entity shall recognize revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service ( i.e. an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset .

9. When (or as) a performance obligation is satisfied , an entity shall recognise as revenue the amount of the transaction price (excluding variable consideration) that is allocated to that performance obligation . Determining the transaction price (TP) An entity shall consider the terms of the contract and its customary business practices to determine the TP. TP 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, some sales taxes). Consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both . Step-3 : Determine the “TRANSACTION PRICE”

10. While determining the TP, an entity shall consider the effects of all of the following :

11. Where a contract contains elements of variable consideration (VC), the entity will estimate the amount of VC to which it will be entitled under the contract Examples of VC includes discounts, rebates, refund, credits, price concessions, incentives, performance bonuses, penalties and other similar items VC is also present if an entity’s right to consideration is contingent on the occurrence or non-occurrence of a future event.  For example, Performance Bonus on achievement of a specified milestone. Specifically , variable consideration is only included in the transaction price if, and to the extent that, it is highly probable that its inclusion will not result in a significant revenue reversal in the future when the uncertainty has been subsequently resolved. For example : where an entity agrees to transfer control of a good or service in a contact with customer at the end of 30 days for Rs . 1,00,000 and if it exceeds 30 days, the entity is entitled to receive only Rs . 95,000, the reduction of Rs . 5,000 shall be regarded as VC. Variable Consideration

12. For Example: On April 1 , 2017, M/s XYZ enters into an annual contract with a customer for sale of a product for a consideration of Rs . 100 per unit. However If customer purchases more than 75 units during the year, the total consideration will be Rs . 80 per unit retrospectively applied (i.e., all purchases will be at Rs . 80 per unit ). Initially , M/s XYZ does not believe the customer will purchase more than 75 units. However, on August   10, 2017, the entity analyze from the customer’s purchasing pattern that the customer will meet this target. Assume that the purchase pattern is as follows: April 10 units May 15 units June 15 units August 10 12 units Since total contract consideration of Rs . 100 per unit includes a fixed component of Rs . 80 per unit and a variable component of Rs . 20 per unit, the variable component must be assessed to determine the estimated value and whether this amount should be constrained. Consider the following:

13. April-2017 - Based on past history of the customer, M/s XYZ believe that customer will not meet the target required for the consideration to drop to Rs . 80 per unit. M/s XYZ believes instead there is a high probability a significant revenue reversal will not occur because the target expected purchases will not exceed 75 units and therefore M/s XYZ expects to be entitled to consideration of Rs . 100 per unit rather than Rs . 80 per unit. M/s XYZ records the total consideration amount of Rs . 100 per unit. 30-June-2017 - If the conclusions reached at inception remain appropriate, revenue for the period ending 30-June-2017will be recognized using the Rs . 100 per unit price. 10-August-2017 - M/s XYZ now estimates that because of increased purchases the customer will likely exceed the targeted 75 units. It is now highly probable a significant revenue reversal will occur. Therefore revenue will have to be retrospectively adjusted to the Rs . 80 per unit. This adjustment will be recorded in the current period, meaning August 2017 (i.e., in Q2). Time Period Amount of Revenue to be Recognized April – June 2017 Rs . 4,000 = (10 + 15 + 15 units) x Rs . 100 per unit 10-August -2017 Rs . 160 = (10 + 15 + 15 units) x Rs . 80 per unit + (12 units) x Rs . 80 per unit

14. 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: (a) The expected value —the expected value is the sum of probability-weighted amounts in a range of possible consideration amounts. This method may be an appropriate estimate of the amount of variable consideration if an entity has a large number of contracts with similar characteristics . (b) The most likely amount —the most likely amount is the single most likely amount in a range of possible consideration amounts. This method may be an appropriate estimate of the amount of variable consideration if the contract has only two possible outcomes (for example, an entity either achieves a performance bonus or does not ). Both the methods requires management consideration of historical, current and forecast information. Any one method to be consistently applied .

15. Example: Variable consideration – expected value method On 1 January 2018, a vendor enters into a contract with a customer to build an item of specialised equipment, for delivery on 31 March 2018. The amount of consideration specified in the contract is INR 2 million, but that amount will be increased or decreased by INR 10,000 for each day that the actual delivery date is either before or after 31 March 2018. In determining the transaction price, the vendor considers the approach that will better predict the amount of consideration that it will ultimately be entitled to, and determines that the expected value method is the appropriate approach. This is because there is a range of possible outcomes. Variable consideration – most likely amount A vendor enters into a contract with a customer to construct a building for INR 1 million. The terms of the contract include a penalty of INR 100,000 if the building has not been completed by a specified date. In determining the transaction price, the vendor considers the approach that will better predict the amount of consideration that it will ultimately be entitled to, and determines that the most likely amount method is the appropriate approach. This is because there are only two possible outcomes; either the penalty will be applied or it will not. The estimated amount of variable consideration is updated at each reporting date to reflect the position at that date, and any changes in circumstances since the last reporting date.

16. In determining the transaction price, an entity should adjust the promised amount of consideration for the time value of money if significant financing components exist. However , an entity should not recognize a financing component, if any of the following situation is satisfied :- Advance is paid by the customer but the transfer of the goods and/or services is at the discretion of the customer, or a substantial amount of the consideration promised by the customer is variable and the amount or timing of that consideration varies on the basis of the occurrence or non-occurrence of a future event that is not substantially within the control of the customer or the entity (for example, if the consideration is a sales based royalty) or Difference between the consideration defined and the cash selling price exists due to some other specified reason other than financing . E.g . If difference exists due to an escalation clause or an amount levied on non abidance of a particular clause, etc. Financing Component

17. Process of identifying the financing component FINANCING COMPONENT Existence of difference between defined consideration and cash selling price Expected time gap between transfer of goods/services and payment Proximity of the financing component identified with the prevailing interest rates inmarket Time value of money to be considered only if time gap is more than 1 year Evaluation of Existence Interest Expense If customer pays in advance Interest Income If customer pays at a later date To be disclosed separately from other interest incomes / expenses Interest component to be calculated using the discounting technique Rate between the customer and the entity , had the transaction been only a financing transaction . Credit characteristics of person receiving finance. E.g. Credit ratings The fact that the financing transaction is secured or unsecured Factors affecting discount rate

18. 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. 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. Non Cash Consideration

19. Consideration payable to a customer includes cash amounts that a vendor pays, or expects to pay, to a customer (or to other parties that purchase the vendor’s goods or services from the customer), credits or other items such as coupons or vouchers that can be applied against amounts owed to the vendor Consideration payable to a customer is accounted for as a reduction of the transaction price (and hence, a reduction of revenue), unless the payment to the customer is in exchange for a distinct good or service that the customer transfers to the vendor . A vendor might sell goods / services to a customer and at the same time purchases goods/services from the same customer. If the amount of consideration payable to the customer exceeds the fair value of a distinct good or service that the vendor receives in exchange, the difference is accounted for as a reduction in vendor’s sales transaction price If a vendor cannot reasonably estimate the fair value of a good/service received from the customer, then full amount of the consideration payable to the customer is deducted from the vendor’s own transaction price (& hence revenue). When the consideration payable to a customer is treated as a reduction of the transaction price the reduction of revenue is recognised when (or as) the later of either of the following occurs: – The vendor recognises revenue for the transfer of the related goods or services to the customer – The vendor pays, or promises to pay, the consideration, even if the payment is conditional on a future event. Such a promise may be implied by the vendor’s customary business practices. A key point is that any amount paid by a vendor to its customer will be accounted for as a reduction in revenue, unless that payment is in return for a distinct good or service. Payable to a Customer

20. The amount allocated to each separate performance obligation reflects the consideration to which a vendor expects to be entitled in exchange for transferring the related goods or services to the customer. At contract inception a vendor is required to determine the stand-alone selling price (SASP) of the good or service underlying each performance obligation and then allocate the transaction price proportionately based on these SASPs . The ‘stand-alone selling price’ is the price at which a vendor would sell a good or service separately to a customer. When a SASP is not directly observable , it is estimated . Example: A retailer sells a computer-and-printer package for Rs . 900. The retailer has determined that these are two separate performance obligations & regularly sells printer for Rs . 300 and computer for Rs . 700. In this case, the entity will allocate the Rs . 900 total transaction price as follows: • Printer : Rs . 270 = Rs . 900 × ( Rs . 300 / ( Rs . 300 + Rs . 700 )) • Computer: Rs . 630 = Rs . 900 × ( Rs . 700 / ( Rs . 300 + Rs . 700 )) In this transaction, there is an inherent discount of Rs . 100 which does not relate to a specific PO & is therefore allocated to all POs on a relative stand-alone selling price basis. Step-4 : Allocate Transaction Price to separate POs

21. Suitable methods for estimating the SASP of a good or service: i ) Adjusted market assessment approach Estimating the price that a customer in the particular market would be prepared to pay , which might include referring to prices charged by the vendor’s competitors for similar goods or services, and adjusting those prices as necessary to reflect the vendor’s costs and margins. ii) Expected cost plus margin approach Estimating the expected costs of satisfying a performance obligation and adding an appropriate margin . iii) Residual approach Deducting observable SASPs that are available for other goods or services to be supplied from the total contract price. However, the use of this approach is restricted to those goods or services for which there is a broad range of selling prices (i.e. selling price is highly variable and representative stand alone selling price can not be ascertained or in circumstances in which the selling price is uncertain because no selling price has been set for the good or service and it has not previously been sold on a stand-alone basis .

22. Allocate Proportionately based on ‘Standalone Selling Prices ’ ( SASP) It is the Sum of SASPs – Contract Consideration allocate a discount proportionately to all performance obligations Allocate to a specific performance obligation or a good or a service, if clearly identifiable. Else, allocate as per SASP Allocation Transaction Price Discounts Variable Considerations

23. 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 good or service ( i.e an asset) to a customer. 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 ”. Step-5 : Recognise revenue when the entity satisfies a PO Satisfy Performance Obligation by Transferring a promised good or service Customer obtains control of good or service Recognise Revenue

24. Customer Obtains Control of Good or Service : Goods and services are assets, even if only momentarily, when they are received & used (as in case of many services) Control of an asset refers to: ability to direct use of & obtain substantially all of the remaining benefits from asset ability to prevent other entities from directing use of and obtaining benefits from an asset benefits of an asset are potential cash flows (inflows or savings in outflows) that can be obtained directly or indirectly in many ways

25. Determine at the contract inception, whether it satisfy a performance obligation “OVER TIME” or “AT A POINT OF TIME” : An entity transfers control of a good / service over time and, therefore, satisfies a performance obligation and recognises revenue over time, if one of the following criteria is met: (a) the customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs (b) the entity’s performance creates or enhances an asset (for example, work in progress) that the customer controls as the asset is created or enhanced or (c) the entity’s performance does not create an asset with an alternative use to the entity (see paragraph 36) and the entity has an enforceable right to payment for performance completed to date If a performance obligation is not satisfied over time, an entity satisfies the performance obligation at a point in time. F ollowing indicators of transfer of control to be considered (in addition to requirements for control ) to determine point in time : Entity has a present right to payment for the asset Customer has legal title to the asset Entity has transferred physical possession of the asset Customer has significant risks and rewards of ownership of the asset Customer has accepted asset

26. Methods for measuring progress towards complete satisfaction of a performance obligation satisfied “OVER TIME” : Output methods This methods recognize revenue on the basis of direct measurements of the value to the customer of the goods / services transferred to date relative to the remaining goods or services promised under the contract. Output methods include methods such as surveys of performance completed to date, appraisals of results achieved, milestones reached, time elapsed and units produced or units delivered. This method would not provide a faithful depiction of the entity’s performance if the output selected would fail to measure some of the goods or services for which control has transferred to the customer. For example , output methods based on units produced or units delivered would not faithfully depict an entity’s performance in satisfying a performance obligation if, at the end of the reporting period, the entity’s performance has produced work in progress or finished goods controlled by the customer that are not included in the measurement of the output .

27. (b) Input methods Input methods recognize revenue on the basis of the entity’s efforts or inputs to the satisfaction of a performance obligation (for example, resources consumed, labour hours expended , costs incurred, time elapsed or machine hours used) relative to the total expected inputs to the satisfaction of that performance obligation. A shortcoming of input methods is that there may not be a direct relationship between an entity’s inputs and the transfer of control of goods or services to a customer. Therefore, an entity shall exclude from an input method the effects of any inputs that, do not depict the entity’s performance in transferring control of goods or services to the customer

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