Introduction of IND AS 115
This standard can establish principles for reporting useful information about the amount, timing, nature, cash flows, uncertainty and revenue arising from a customers contract.
The basic principle is that an entity should recognize revenue for depicting the transfer for promising goods or services for customers in an amount that is reflecting the consideration for which the entity is expecting to be entitled for exchange of those goods or services.
The standard is specified by the accounting for an individual contract with a customer. However, as according to a practical expedient, an entity might be applied for this standard to a portfolio of contracts with close characteristics if the entity is reasonably expecting that effects of the standard applied to the portfolio would not differ materially by the application of this Standard for the individual contracts (or performance obligations) within that portfolio.
SCOPE of IND AS 115
Ind AS 115 can be applied for all contracts with customers for providing goods or services that are the outputs of the entity’s ordinary time of business in exchange for consideration unless specifically excluded from the scope of the new guidance, as described below.
An entity should apply this standard for all contracts with customers, excluding the following:
(a) Within the scope of Ind AS 116 leasing the contract.
(b) Within the scope of Ind AS 104 contracts of insurance.
(c) Obligations, financial instruments and other contractual rights 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.
(d) Various non-monetary exchanges between entities in the same line of business for facilitating sales for potential customers.
For e.g., this standard will not be applied on a contract between two oil companies that are agreed to an exchange of oil for fulfilling the demand from their customers in different specified locations on a timely basis.
This standard is applicable only if the contracts counterparty is a customer. A customer is a person that is having contract with an entity for obtaining goods or services that are considered as an output of the entity’s ordinary activities in exchange for various consideration.
A counterparty of the contract would not be a customer if, for example, the counterparty is have been contracted with the entity for participating in an activity or process in which the parties to the contract shared in the risks and benefits that are resulted from the activity or process (such as development of an asset in a collaboration arrangement) rather than obtaining the output of the entity’s ordinary activities.
A contract with a customer can be partially within the scope of Ind AS 115 and other Ind AS. In such cases, the following steps should be followed for identifying that how it should be splitted between Ind AS 115 and other Ind AS:
(i) If the other Ind AS is specified that how to separate and measure a portion of the contract, then application of that guidance should be first. The amounts should be measured under other Ind AS should be excluded from the transaction price that have been allocated with the performance obligated under the Ind AS 115.
(ii) If the other Ind AS is not stipulated that how to separate and measure a portion of the contract. Ind AS 115 would be used for separating and measuring that portion of the contract (refer to discussion relating to Step 4 – Allocation of the transaction price for performance obligation).
Ind AS 115 is also specifying the accounting for the incremental costs for obtaining a contract with a customer and for the costs which are incurred for fulfiling a contract with a customer if those costs are not coming within the scope of another Standard. An entity should apply those paragraphs only for the costs which are incurred that is related to a contract with a customer (or stands as the part of that contract) that comes within the scope of this standard.
OVERVIEW of IND AS 115
After more than years of work, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) had published their largely converged standards on revenue recognition in May 2014. The IFRS 15 is issued by IASB 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, its notification dated 28th March 2018.
Ind AS 11 and Ind AS 18 is replaced by Ind AS 115.
Ind AS 115 is based on a basic principle that requires an entity to recognize revenue:
(a) In a manner that is depicted for the transfer of goods or services to the customer.
(b) At an amount that is reflecting the consideration for the entity for expecting can be entitled for exchanging those goods or services. For achieving the basic principle, an entity should apply the following five-step model:
Step 1: Identification of the customer’s contract.
Step 2: Identification of the obligations performance in the contract.
Step 3: Determining the transaction price.
Step 4: Allocation of the price transaction to the performance obligations in the contract.
Step 5: Recognizing revenue when the entity is satisfying its performance obligations.
Entities would need for exercising judgment while considering the terms of the contract and all of the facts and circumstances, which is including implication contract terms. Entities will also have to consistently apply the standard’s requirements to contracts with similar characteristics and in similar circumstances.
TRANSITION to IND AS 115
Ind AS 115 is commisioned for annual reporting periods beginning on or after 1st April 2018.
Entities are required for applying in the new revenue standard using either of the following two approaches:
(a) Full retrospective approach: retrospectively to each prior period presented following Ind AS 8, subject to some practical expedients mentioned in the standard.
(b) Modified retrospective approach: retrospectively with the cumulative effect of initial application recognized at the date of initial application.
When applying the full retrospective method, an entity shall restate all prior periods presented following Ind AS 8. It 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 a modified retrospective approach, an entity does not restate prior periods presented, and the cumulative effect of the initial application can be recognized in the opening retained earnings of the first year of application of Ind AS 115.
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.
An agreement is to be made between a two or a more parties is known as a contract that is creating enforceable rights and obligations. Enforceability of the obligations and the rights in a contract is a matter of law.
Contracts can be oral, written or implied by a customary business practices of an entity. The processes and practices for establishing contracts with customers can vary across various legal jurisdictions, industries, and entities.
In addition, they can also vary within an entity (for example, they might have to depend on the class of the customer or the nature of the goods or services which are promised). An entity should consider those practices and processes in determining whether and when an agreement with a customer creates enforceable rights and obligations.
For example, suppose an entity has an established practice of starting performance based on oral agreements with its customers. In that case, it may determine that such oral agreements meet the definition of a contract. As a result, an entity might need to account for a contract as soon as the performance begins rather than delaying revenue recognition until the arrangement is documented as a signed contract.
Ind AS’s guidance clarifies that the rights and obligations must be “enforceable” for an entity for applying the five-step revenue model. Enforceability as according to the matter of law, so an entity needs for considering the local relevant legal environment for making that determination. That is also said that, while the contract must be enforceable legal, oral or even implied in promises might give rise to performance obligations in the contract.
STEP 2- IDENTIFYING PERFORMANCE
Under the five-step model of Ind AS 115, the second step in accounting for a contract with a customer is the identification of the performance obligations.
Identifying performance obligations can be a crucial process in the five-step model. Performance obligations are considered as a unit of account to apply the revenue standard. Identification of performance obligations requires a higher degree of judgment in cases where more goods or services have been promised in a contract.
Also, it is needeed to be determined whether those performance obligations should be accounted for separately or in combination with other goods or services which are promised in the contract.
The concept of performance obligations can be a cornerstone of Ind AS 115 with the revenue recognition model. The timing of revenue recognition can be based on the satisfaction of performance obligations rather than the contract can be as a whole. This area can be sometimes referred to as multiple element arrangements.
STEP 3: DETERMINING THE TRANSACTION
After identifying the contract in Step 1 and the performance obligations in Step 2, an entity next applies Step 3 to determine the contract’s transaction price. The objective of Step 3 is to predict the total amount of consideration to which the entity will be entitled to the contract.
The consideration which is promised in a contract with a customer might include fixed amounts, variable amounts, or both. Further, an entity shall consider the terms of the contract and its customary business practices to determine the transaction price.
To determine the transaction price, an entity shall assume that the goods or services will be transferred to the customer as promised following the existing contract. The contract would not be cancelled, renewed or even modified.
The nature, timing, and amount of consideration which is promised by a customer affect the transaction price estimate.
STEP 4: ALLOCATION OF THE TRANSACTION PRICE FOR PERFORMANCE OBLIGATIONS
Allocation objective- While allocating the transaction price, the objective of the entity should be for allocating the transaction price for each performance obligation (or distinct good or service) in an amount that is depicting the amount of consideration for which the entity expected to be entitled for exchange in transferring the goods or services promised to the customer.
For meeting the above allocation objective, an entity should allocate the transaction price for each performance obligation which is identified in the contract on a relative stand-alone selling price basis as per the standard, except for allocating discounts and for allocating consideration that includes variable amounts.
Simply put, there are two exceptions to the general allocation guidance: in Ind AS 115
- Allocating discounts
- Allocating variable consideration
Under these exceptions, an entity allocates a disproportionate amount of the transaction price to specific performance obligations based on evidence that suggests the discount or variable consideration relates to those specific performance obligations.
Determining stand-alone selling price-
For allocating the transaction price on a relative stand-alone selling price basis, an entity must first determine the stand-alone selling price of the particular good or service underlying each performance obligation. The stand-alone selling price is when an entity would trade a promised good or service separately for a customer.
The best confirmation of a stand-alone selling price is – the noticeable price of a good or service when the entity is selling that good or service separately in similar circumstances and to similar customers.
An entity should decide the stand-alone selling price at contract inception of the distinct good or service which are underlying on each performance obligation. In the contract and allocate the transaction price in proportion to those stand-alone selling prices to allocate the transaction price to each performance obligation.
A relative stand-alone selling price basis. Stand-alone sales prices can be determined at inception of a contract and are not updated for reflecting the changes between contract inception and when performance is complete.
Furthermore, if the contract is modified and treated as a termination of the existing contract and the creation of a new contract, the entity would update its estimate of the stand-alone selling price at the time of the modification. If the contract is modified and the modification is treated as a separate contract in Ind AS 115.
The accounting for the initial contract would not be affected (and the stand-alone selling prices of the underlying goods and services would not be updated), but the stand-alone selling prices of the distinct goods or services of the new, separate contract would have to be determined at the time of the modification.
A price which is contractually stated or a list of price of a good or service may be (but should not be assumed to be) the stand-alone sales price of that good or service.
Suppose a stand-alone selling price is not directly observable, for example. In that case, the entity does not sell the good or service separately; an entity should estimate the stand-alone sale price at an amount that would allocate the transaction price meeting the allocation objective.
When estimated a stand-alone sales price, an entity should consider all information which includes market conditions, entity-specific factors, market conditions and information about the customer or class of customer which can be reasonably available to the entity. In doing so, an entity shall maximize observable inputs and apply estimation methods consistently in similar circumstances.
Evaluating the evidence related to estimating a stand-alone selling price may require significant judgment.
An entity should establish policies and procedures for estimating stand-alone selling prices and apply those policies and procedures consistently to similar performance obligations. As a best practice, an entity should document its evaluation of the market conditions and entity-specific factors considered in estimating each stand-alone selling price, including factors that it considers to be irrelevant and the reasons why in Ind AS 115.
STEP 5: SATISFYING PERFORMANCE
An entity should acknowledge revenue when the entity is satisfied by a performance obligation by conveying goods or services which are guaranteed to a customer. An asset is transferred when (or as) the customer is obtaining the control of that asset.
In other words, the transfer of ‘control’ is the key determinant under Ind AS 115. Decision making on how ‘control’ will be transferred to the customer is done at the transaction’s inception.
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