Revenue recognition standard: The Five step model
Five step model for
revenue recognition:
(Reference taken from: INDAS115.pdf
(mca.gov.in))
I.
Identifying
of Contract – Defines a
contract and a customer and lays down five mandatory criteria to be met for
identification of a contract. Depending on the parties’ local practices; a
contract can be oral, written or implied.
a. The parties have approved the contract (whether
in writing or orally) and have committed to discharging their respective
obligation.
b. Each party’s right in relation to the transfer
of good or services are identifiable.
c. The payment terms in relation to the transfer of
good and service can be identified.
d. Economic benefit from the contract can be
derived by both the parties respectively.
e. An entity may collect the full consideration or
may collect a lower price than that stated in the contract if a discount has
been offered to the customer (discussed in detail in ‘Determining the transfer
price’). Probability of receiving payment from the customer is to be evaluated
solely by customer’s ability and intention to pay.
f. Combination of contracts – An entity may combine
two or more contracts with the same customer at the time of inception or at a
late date if:
i. The contracts were negotiated as a package and
have a unified commercial objective.
ii. The consideration to be paid in one contract
depends on the consideration or performance of the other contract.
iii. The good or service, whole or in part, promised
in the contracts can be identified as a single performance obligation for the
seller.
g. Contract modification
i. A contract modification is a change in the scope
or price or both of a contract and should be approved by the parties.
ii. In case of dispute where the parties do not
agree on the change in either scope or price or both a contract modification
may still exist.
iii. Where modified contract is to be treated as a
separate contract if:
1. The scope of contract increases because of
addition to promised goods or services.
2. Increase in consideration of the contract
reflects the entity’s standalone selling prices for the additional good or
service promised in the modification.
iv. Where modified contract is not to be treated as
a separate contract if:
1. If the remaining goods or service are distinct
from the those transferred up to the date of modification. The new
consideration to be allocated to the remaining performance obligation is the
sum of:
a. The consideration promised by the customer,
including amounts already received, that had been included in the transaction
price but hasn’t been recognized as revenue.
b. The consideration promised as part of the
modification
2. If the remaining goods or services are not
distinct and, therefore, form part of a single performance obligation that is
partially satisfied at the date of the contract modification. The effect of
contract modification should be on the transaction price.
3. If the remaining goods or services are a
combination of items (1) and (2), then the entity shall account for the effects
of the modification on the unsatisfied (including partially unsatisfied)
performance obligations in the modified contract.
II.
Identifying
performance obligations
– Sets out the criteria to access and identify the goods and services promised
and identify each promise to transfer good or service to the customer as a
performance obligation.
a. A good or service or a bundle of goods or
service that is distinct, or
b. A series of distinct good and service that are
substantially the same and that have the same pattern of transfer to the
customer
c. The performance obligation may not be explicitly
stated in a contract, it may be based on the business practices, published
policies or specific statements.
d. Performance obligation do not include any
activities that do not result in of transfer goods or services.
e. Definition of distinct goods or service
i. Sale goods produced by an entity (sale of
manufactured goods)
ii. Resale of goods produced by an entity (Retail
sale)
iii. Resale of rights to a goods or services
purchased by an entity (Sale of ticket bas an entity acting as the principal)
iv. Performing a contractually agreed upon task for
a customer
v. Providing a service of standing by to deliver
goods or service (customer support)
vi. Providing service of arranging for another party
to deliver goods or service (acting as someone’s agent)
vii. Granting rights to goods or services that the
customer can then resell to its customer
viii.
Constructing,
manufacturing or developing an asset on behalf of a customer
ix. Granting licenses
x. Granting options to purchase additional goods or
services
f. Two
criteria need to be met for a good or service to be considered a distinct
obligation:
i. The customer can benefit from the goods or
services either on its own or grouped with other goods or services readily
available with them
ii. The promise to transfer goods or services to the
customer is separately identifiable from other such goods or services stated in
the contract.
g. Goods or services can be identified separately
if:
i. The entity is not using the goods or services as
an input to produce/deliver goods or services promised in the contract
ii. The good or service do not significantly modify
another good or service
iii. The good or service is not dependent on another
good or service promised in the contract
III.
Determine
transaction price – The entity shall
consider the contract and its customary business practices in determining the
transaction price. The consideration promised the contract may include fixed
price, variance price or both.
a. Variable consideration
i. The seller may estimate the amount of
consideration its entitled to.
ii. An amount of consideration can vary because of
discounts, rebates, refunds, credits, price concessions, incentives,
performance bonuses, or other similar items.
iii. The promised consideration can also vary if an
entity’s entitlement to the consideration is contingent on the occurrence or
non-occurrence of a future event.
iv. The seller may estimate the consideration due
either by 1) The expected value or 2) The most likely amount, one of which is
to be applied consistently throughout the contract term.
v. An entity shall recognise a refund liability if
the entity receives consideration from a customer and expects to refund some or
all of that consideration to the customer.
vi. Whole or part of variable consideration maybe be
included in the transaction price on condition that a significant reversal will
not occur when the uncertainty associate is resolved.
b. Significant financing component
i. Transaction price to be adjusted for time value
of money.
ii. Recognise revenue at an amount that reflects the
price that a customer would have paid for the promised goods or services if the
customer had paid cash for those goods or services when or as good or services
are transferred to the customer.
iii. A contract does not have a significant financing
component when:
1. Customer paid for the goods or services in
advance and the transfer is at the customer’s discretion.
2. Consideration is variable and the amount or
timing varies on the basis of a future event.
3. The difference in promised consideration and
cash value is due to reasons other than provision of finance.
iv. Not applicable for a period less than equal to
12 months.
v. Effects of financing to be presented separately
than the revenue from contracts in financial statements
c. Non-cash consideration
i. Where payment is to be made in a form other than
cash, its should be at fair value of the mode of payment
ii. If fair value can’t be accessed accurately,
standalone selling price of goods or services promised to the customer is to be
used to measure the consideration.
d. Consideration payable to the customer maybe cash
or credit owed to the customer which can be applied against consideration owed
by the customer.
IV.
Allocate
transaction price - The objective
when allocating the transaction price is for an entity to allocate the
transaction price to each performance obligation (or distinct good or service)
in an amount that depicts the amount of consideration to which the entity
expects to be entitled in exchange for transferring the promised goods or
services to the customer.
a. Allocation based on stand-alone selling prices
i. Determine standalone selling price underlying
performance obligation and allocate in proportion to each performance
obligation of the standalone selling price.
ii. Suitable method to estimate standalone selling
price:
1. Adjusted market assessment approach
2. Expected cost plus a margin approach
3. Residual approach
b. Allocation of discount - Customer receives a
discount when the sum of standalone selling price is exceeds the selling price
in the contract
c. Allocation
of variable consideration
i. Maybe attributable to the entire contract or a
specific part of it.
ii. It may be allocated to an entire or a part of a
performance obligation
d. Changes in transaction price – Allocation of
changed transaction price is to be similar to allocation of transaction price
as at contract inception.
V.
Satisfaction
of performance obligation (Recognition of revenue) – An entity shall recognize revenue as and when
the transfer of goods or service promised to the customer takes place and
performance obligation is satisfied as promised in the contract. An asset
(goods and service are assets) is considered transferred when the customer
obtains control of that asset.
a. Performance obligation maybe satisfied at a
point in time or over time and transfer control to the customer.
b. Control of an asset – Control refers to the
ability to direct the use of and obtain all residual benefits from the assets,
and preventing other entities’ from the same.
i. using the asset to produce goods or provide
services
ii. using the asset to enhance the value of other
assets
iii. using the asset to settle liabilities or reduce
expenses
iv. selling or exchanging the asset
v. pledging the asset to secure a loan
vi. holding the asset.
c.
Performance obligation
satisfied over time - When an entity transfers control of goods or service over
time, it satisfies a performance obligation over time and recognizes revenue
over time. (Concept of deferred revenue)
i. Recognise revenue over time by measuring the progress towards complete
satisfaction of the performance obligation.
ii. An entity shall apply a single method of measuring progress for each
performance obligation satisfied over time and the entity shall apply that
method consistently to similar performance obligations and in similar
circumstances.
d.
Performance obligation at
a point in time – The point in time when
the customer obtains control of assets refer (b) above. In addition points to
consider but not limited to:
i. The entity has a right to payment for the asset
ii. The customer has legal title to the asset
iii. The entity has transferred physical possession of the asset
iv. The customer has significant risks and rewards of ownership of assets
v. The customer as accepted the asset
e.
Methods of measuring
progress
i. An entity shall apply a single method of measuring progress for each
performance obligation satisfied over time and the entity shall apply that
method consistently to similar performance obligations and in similar
circumstances. Also nature of goods and services to be considered when applying
a certain method.
ii. The entity shall exclude such goods and services for which the control
in not being transferred to the customer and include all goods and services for
which control is being transferred for the purpose of measurement
iii. An entity may change the measure of satisfying a performance obligation
over time based on change in circumstances
iv. An entity shall recognise revenue for a performance obligation satisfied
over time only if the entity can reasonably measure its progress towards
complete satisfaction of the performance obligation.
v. Where reasonable estimation of outcome of performance obligation is not
possible, the entity can recognize revenue only to the extent of cost incurred.
VI.
Contract cost - An entity shall recognise as an asset the incremental costs of
obtaining a contract with a customer if the entity expects to recover those
costs.
a.
Incremental costs are
those costs that are incurred for obtaining a contract and would not have been
incurred if the contract was not obtained.
b.
Any other cost incurred
regardless of obtaining the contract are to be
expensed, unless they can be charged to the customer.
c.
If the amortization period
of incremental cost in (a) is less than equal to 12 months it may be expensed.
VII.
Costs to fulfil a contract
a.
If the costs incurred in
fulfilling a contract are not within the scope of another standard (Inventory,
PPE, etc.), it can be recognized as an asset if all the following conditions
are met:
i. Cost relate directly to a contract or an anticipated contract
ii. The costs generate or enhance resources that will be used to satisfy
performance obligation at a future date
iii. The cost is recoverable
b.
Cost that relate directly
to a contract
i. Direct labour
ii. Direct material
iii. Allocations of costs that relate directly to the contract or to contract
activities.
iv. Costs that are chargeable to the customer
v. Other costs incurred due to the existence of the contract
c.
Following costs are to be
recognized as expenses when incurred
i. General and administrative
ii. Cost of wastage
iii. Costs that relate to satisfying performance (wholly or partly)
iv. Costs related to expenses that cannot be categorised if incurred for a
satisfied performance obligation or not
VIII.
Amortisation and
impairment
a.
Costs recognised as
incremental costs need to be amortized on a basis that is consistent with
transfer of goods or services to which the cost relates
b.
Amortisation to be updated
wo reflect any changes to the expected timing of the transfer of such goods or
service
c.
Impairment loss can be
recognised in the P&L to the amount - Carrying amount less remaining
consideration the entity expects to receive less the costs that relate directly
to providing those goods or services that have not been recognised as expenses.
d.
To determine the amount to
consideration that is expected to be received the principle of determining the
transaction price needs to be applied and adjusted for customer’s credit risk
e.
Prior to recognising impairment
loss on asset under the standard, impairment loss related to the contract must
be recognised.
f.
If the impairment
conditions no longer exist the impairment loss recognised previous needs to be
reversed. Carrying cost of the asset can not exceed the amount that would have
been determined if no impairment had been recognized
IX.
This standard does not
apply to:
a.
Leases
b.
Insurance contracts
c.
Financial instruments
d.
Consolidated financial
statements
e.
Joint arrangements
f.
Separate financial
statements
g. Investments in associates and joint ventures
Each to their own:
Ind AS 115 vs IFRS 15:
1.
Ind AS 115 sets the
standard for penalties separately in paragraph 51AA while per paragraph 15 of
IFRS consideration may vary due to a number of things including penalty.
2.
IND 115 has separately
included paragraph 109AA for entities to include excise separately.
(Reference taken from: https://taxguru.in/chartered-accountant/ind-as-115-ifrs-15-revenue-contracts-customers.html)
ASC 606 vs IFRS 15:
1.
Contract cost: ASC 606
allows companies to capitalize certain incremental costs e.g. sales commission.
IFRS insists that the capitalization of contract costs should generate future
economic benefits, therefore is more stringent in this regard.
2.
Presentation of revenue:
ASC 606 requires companies to present revenue that is consistent with transfer
of control to the customers. IFRS requires companies to present revenue on a
gross or net basis depending on whether they are acting as a principal or
agent. Principal owns goods or services that will be transferred to the
customer. An agent acts as an intermediatory between principal and customer.
Disclaimer: This is purely an academic pursuit. The views/opinions expressed above are my own and does not reflect the views of my employer.
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