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Revenue Recognition as per IND AS-115 and Situation for Deferment of the Revenue

CA Bharat Sonkhiya, CA Vikash Maharshi & Sahil Dewan - [2024] 158 taxmann.com 103 (Article)

To start with, first we need to understand what actually revenue is? Basically revenue is the gross inflows of cash, receivables and other consideration arising in the course of ordinary activities of an enterprise from the sale of goods, from the rendering of services, and from the use by others of enterprises resources.

For recognizing revenue, AS-9 and IND AS-115 provides the guidelines.

In IND AS regime, IND AS -115 deals only with the revenue recognitions related to contract with customers, other income like lease rent, finance income etc. dealt by their respective IND AS.

Revenue recognition principles; AS vs IND AS

As such there is no such difference between AS and IND AS in case of revenue recognition. Both deals with the same principle that revenue will be recognized only when risk and rewards have been transferred from seller to buyer and seller has no control over goods.

IND AS-115 provides a comprehensive framework for recognizing revenue arising from contracts with customers. It outlines the principles that an entity should apply to determine the amount and timing of revenue recognition.

So let's understand how the revenue will be recognized under IND AS regime-

IND AS-115 provides five step model for recognizing revenue, which are as follows -

(1)?Identification of the Contract: Revenue recognition begins when a contract with a customer is identified. A contract is an agreement between two or more parties that creates enforceable rights and obligations.

(2)?Identification of Performance Obligations: The standard requires the identification of distinct performance obligations in the contract. Performance obligations are promises to transfer goods or services to the customer.

(3)?Determination of Transaction Price: The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer.

(4)?Allocation of Transaction Price: If a contract has more than one performance obligation, the transaction price is allocated to each performance obligation based on its standalone selling price.

(5)?Recognition of Revenue: Revenue is recognized when (or as) a performance obligation is satisfied, i.e., when control of the promised goods or services is transferred to the customer.

Presentation and Disclosures: The standard requires entities to provide relevant information in the financial statements to enable users to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

Now to understand more about revenue recognition, first we need to discuss further about performance obligation. So the question arises what are the performance obligations and how they affect recognition of revenue?

A performance obligation is a promise to provide a distinct good or service or a series of distinct goods or services as defined in the contract. In simple terms performance obligation is a "Promise" to deliver goods or services in lieu of payment.

As per IND AS 115, A good or service that is promised to a customer is distinct if both of the following criteria are met:

(a)?The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (i.e. the good or service is capable of being distinct); and

(b)?The entity's promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (i.e. the good or service is distinct within the context of the contract).

Now let's take an Example for a better understanding:

EXAMPLE: XYZ Company has a work order contract with BSNL for erection of towers and other O&M Services. As per the contract, Company can issue invoice to the BSNL as and when any goods or services is purchased by XYZ Company for delivering the end product or service to BSNL. These are the details for following supply of services as per work order contract with BSNL:

Now, to recognise revenue firstly we need to identify the performance obligation in our case, the services in the contract (activity 1,2 & 3) are distinct because it satisfies both the conditions of Para 27 of IND AS 115 namely:

(a)?The BSNL can procure the above 3 activities either on its own or together with other resources that are readily available to the customer (i.e. the good or service is capable of being distinct); and

(b)?The entity's promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (i.e. one activity is distinct from another within the context of the contract) as the activities do not provide a significant service of integrating or significantly modify or customise another or highly dependent on another.

Since the supply is distinct, so no need to take the total transaction price (Rs. 16 Lakhs) stated in the contract as bundle. And also as per IND AS, contractually stated price can be taken as standalone price of the goods or services.

Accounting Treatment

Activity-1, Revenue recognition will be based on percentage of completion method. Invoicing to the clients will be based on milestones as defined in the contract. This would result in the timing of revenue recognition being different from the timing of billing the customers. This should be stated as a part of accounting policy.

According to Ind AS 115 revenue is recognized over time (percentage of completion) either when the performance creates an asset that the customer controls as the asset is created (e.g. work in progress) or when the performance creates an asset with no alternative use and an enforceable right to payment as performance is completed to date has been secured. Revenue is also recognized over time if the customer simultaneously receives and consumes the benefits from goods and services as performed. Under Ind AS 11 construction contracts, with a high degree of individual adjustment were recognized as revenue by reference to the percentage of completion.

Activity-2 Operation & Maintenance charges will be recognised on yearly basis when O&M services has been delivered for that particular year and all other condition also has been fulfilled.

Activity-3 Revenue of cable supply will be recognised as and when services has been delivered.

In above example as we discussed that we are recognising the revenue on the basis of performance obligation has satisfied, in other words we are deferring the revenue until the obligation is being satisfied. Now, we need to understand, what actually deferment of revenue is?

An adjusting entry that pushes a company's recognition of revenue to a future period. Deferrals are all about timing, anytime a customer pays in advance for goods or services to be delivered in the future, the supplying company is expected to book the payment as deferred revenue, sometimes called unearned revenue. Deferred revenue is a liability account, acknowledging that the supplying company owes a good or service to a customer.

Now the next question arises in mind that what is the need of deferment of revenue?

Deferrals are a useful mechanism to help a company's books and records more accurately align the receipt of a product or service with its obligation. They can have a significant impact on a company's financial statements, which are used by internal and external stakeholders as the basis for many business decisions. A company that collects payment in advance of delivering its product should not reflect that payment as revenue until it satisfies its obligation because in case of failure of supply of good and services, it will be required to refund the same.

For example: For instance, a retailer of wedding dresses received deposits for their gowns from 100 brides in March, but he was unable to fulfil his promise to produce the same gowns in April. This retailer would appear to have a robust revenue at year's end if revenue is not deferred, when in fact it doesn't. If revenue is not deferred, the users of financial statement will make wrong decisions considering the advance as revenue. He will recognize the revenue in April if he fulfils his commitment on schedule.

Under IND AS 115, Deferment of revenue is based on Performance obligation being satisfied, in other word we can say revenue can be deferred on the basis of performance obligation satisfied. Here are some instances to get the better understanding where revenue deferral might apply:

Unfulfilled Performance Obligations

A construction company enters into a contract to build a complex structure. The project is ongoing, and certain performance obligations are not yet satisfied.

Revenue recognition may be deferred for the unfulfilled performance obligations until the related work or services are completed, and control is transferred to the customer.

Security Deposits

Assume A customer's security deposit is received by an entity on April 1, 2023, as payment for three years' contract worth of building rent till March 31, 2026, will appear in books as Deposit Liability.

The security deposit is non-refundable and does not represent consideration for a distinct performance obligation.

The revenue recognition of the security deposit will be deferred until the conditions for recognizing the deposit as revenue are satisfied, i.e., revenue will only be recognized when the entity has transferred all promised goods and services to the customer and full consideration is received, which is on March 31, 2026.

Significant Financing Component

An entity enters into a long-term contract with a customer and provides financing as part of the arrangement. If there is a time gap between satisfaction of Performance Obligation by the entity and payment of consideration by the customer, then there is some financing component in the contract.

If there is a significant financing component, the transaction price may be adjusted for the time value of money.

In this there are two cases:

(i)?If entity satisfies its Performance Obligation but customer makes the payment on later date (i.e. Loan by entity to customer), then entity shall recognise revenue at normal selling price (i.e. Cash Selling Price). Extra amount received over Cash Selling Price will be treated as Interest Income over the credit period in Profit & Loss A/C at discounting rate.

(ii)?If customer makes the payment in Advance but entity satisfies its Performance Obligation on a later date (i.e. Loan to entity by Customer), then entity shall recognise Advance received from customer as a Contract Liability (Unearned Income) and charge interest expense on such contract liability over the period in Profit &Loss A/c at discounting rate and when entity satisfies its Performance Obligation, then contract liability will be recognised as revenue on such date.

Revenue recognition may be deferred if the customer has not yet accepted the product or service, and acceptance is a critical criterion for recognizing revenue.

Variable Consideration

An entity enters into a contract with a customer where the payment is contingent on the achievement of certain milestones or performance targets.

It is included in the transaction price on the basis of entity's estimation of receiving that consideration.

Entity shall include variable consideration only to extent that it is highly probable that significant reversal of revenue recognised will not occur in future.

In the following cases, variable consideration will not be included in the transaction price (i.e. cases which indicate significant reversal of revenue in future):

(i)?If the consideration is dependent on factors outside the entity's influence like market volatility. For E.g.: There is a contract that fee will increase by 10% on every increase of 5% in return from stock market.

(ii)?Amount of price concession in consideration which entity generally provides in similar contracts to customers. For e.g.: Where an entity agrees to transfer control of a good or service in a contract 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 variable consideration. In other cases, the transaction price shall be considered as fixed.

If the variable consideration is uncertain and the outcome is not reasonably estimable, revenue recognition may be deferred until the uncertainties are resolved.

Collectability Concerns

If there are significant uncertainties about the collectability of the consideration, revenue recognition may be deferred until collection becomes probable.

Warranties

In the case where company provides warranties with the sale of goods that product complies with agreed specifications, the promised services is a performance obligation and will be recorded separately that means revenue will not be recognised for probable warranty obligations until such warranty period has been expired. In AS regime, we will book full revenue and make provision against the warranty.

NFRA penalizes CA for failure to exercise due diligence in certifying Form 10 DA

In its Order No.0001/2024, dated 03.01.2024, NFRA has fined a CA Rs. 50 Lakhs for lapses in issuing certificate to a listed company in Form 10DA with regard to the correctness of deduction claimed by it under section 80JJAA of the Income-Tax Act, 1961. The major lapse includes-

(a) Failure to verify reorganisation of business with various parties

(b) Failure to exclude employees whose contribution was paid by the Government

(c) Failure to report additional employees during FY 2020-21

(d) Failure to verify payment of additional employee cost by account payee cheque/draft/electronic means

(e) Failure to verify emoluments limit of Rs 25,000 per month for new employees

This story also discusses the key takeaways including-

(a) NFRA’s jurisdiction over auditors of listed companies, other than statutory auditors

(b) Reliance on MRL

(c) Cross-check with annual report while issuing certificates to companies

(d) Apply mind and analyse relevant provisions while interpreting them and document the interpretation arrived at along with the reasons and basis

(e) Reliance on statutory audit report on FS/IFC

Click to Read NFRA Order

That’s it from us for today! Stay Tuned for more updates from Taxmann.com .

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