Indian Accounting Standard (Ind AS) 115 Summary
Ind AS 115, Revenue from Contracts with Customers (the standard), is based on the core principle that an entity recognises revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which it expects to be entitled in exchange for those goods or services.
The standard provides the following five step model for recognition of revenue from contracts with customers:
– Step 1: Identify the contract with 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 obligation
– Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation.
Step 1: Identify the contract with customer
A contract is an agreement between two or more parties that creates enforceable rights and obligations. It may be written, oral or implied by customary business practices and needs to meet all of the following criteria:
– It is legally enforceable
– It is approved and all the parties are committed to their obligations
– Rights to goods or services and payment terms can be identified
– Collection of consideration is considered probable and
– It 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.
Step 2: Identify the performance obligations in the contract
At contract inception, entities are required to identify as a performance obligation an implicit or an explicit promise to transfer to the customer a distinct good or service (or bundle of goods or services)
A good or service that is promised to a customer is distinct if both the following criteria are met:
– The good or service is capable of being distinct: Customers can benefit from the good or service on its own or with other readily available resources. Various factors may provide such evidence, such as when the good or service can be used, consumed, sold for an amount that is greater than scrap value or held in a way that generates economic benefits
– The promise to transfer the good or service is distinct within the context of the contract: The promise to transfer the good or service is separately identifiable from other promises in the contract.
Step 3: Determine the transaction price
Determination of transaction price is done by considering all amounts to which an entity expects to be entitled in exchange for transferring promised goods or services excluding amounts collected on behalf of third parties (for example, some sales taxes). Additionally, the consideration may include fixed amounts, variable amounts, or both.
Step 4: Allocating the transaction price to performance obligation
The objective of allocating transaction price is for an entity to allocate transaction price to each performance obligation in an amount that depicts expected entitlement for transferring the promised goods or services.
The stand-alone selling price is the price at which an entity would sell a promised good or service separately to a customer. Entities shall allocate the transaction price in proportion to the stand-alone selling price of each distinct good or service (determined at contract inception). The stand-alone selling price is determined as below:
– Observable price: the best evidence of a stand-alone selling price is the observable price of a good or service when the entity sells that good or service separately in similar circumstances and to similar customers,
– Estimated price: if a stand-alone selling price is not directly observable, an entity shall estimate it by considering all information available to the entity, maximise the use of observable inputs and apply estimation methods consistently in similar circumstances. Some of the estimation methods are:
- Adjusted market assessment approach
- Expected cost plus a margin approach and
- Residual approach.
Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation
Revenue is required to be recognised when (i.e. at a point in time) or as (i.e. over a period of time) the entity satisfies a performance obligation by transferring the control of a promised good or service to the customer.
A performance obligation is satisfied over time if either:
– Customer simultaneously receives and consumes the benefits as the entity performs
– Customer controls the asset as the entity creates or enhances it or
– The entity’s performance does not create an asset with an alternative use and there is right to payment for performance to date.
If a performance obligation is not satisfied over time, an entity satisfies the. performance obligation at a point in time.
Measurement of revenue is dependent upon the determination of the transaction price allocated to that performance obligation.
The standard includes guidance on accounting for incremental costs to obtain and costs to fulfil a contract that are not in the scope of another standard.
An entity recognises a contract asset when it transfers goods or services before it has unconditional right to payment, and a contract liability when the customer makes a payment before it receives the goods or services.
An entity provides specific quantitative and qualitative disclosures to enable users of the financial statements to understand the nature, timing and uncertainty of revenue and cash flows arising from contracts with customers.