The new standard creates a single source of revenue requirements for all entities in all industries.
Revenue is one of the most important financial statement measures for both preparers and users of financial statements. It is used to measure and assess aspects of an entity’s past financial performance, future prospects and financial health. Revenue recognition is, therefore, one of the accounting topics that is most scrutinised by the investors, analysts and regulators.
The ministry of corporate affairs (MCA) notified Ind AS 115 for application by Ind AS companies from financial years beginning on or after April 1, 2018. Ind AS 115 is largely aligned with the latest version of IFRS 15. Ind AS 115 replaces the legacy revenue standard Ind AS 11 and Ind AS 18. Listed entities should start applying recognition and measurement principles of Ind AS 115 from the quarter ending June 2018. The new standard creates a single source of revenue requirements for all entities in all industries.
This standard is principle-based, consistent with legacy revenue requirements, but provides more application guidance. The lack of bright lines will result in the need for increased judgement.
Gaining an understanding of the new standard, providing early communication to the stakeholders, and advanced planning are important. There will be potential wide-ranging effects of the new standard and, accordingly, an organisation needs to include functions outside the finance department. This includes the IT team, legal, sales, marketing, human resources, investor relations and senior management. Necessary changes to policies, procedures, internal controls and systems will have to be carried out as part of the evaluation of the new standard. Entities will have to at least validate their assumptions if they do not expect significant changes from the new standard. For entities that are going to experience a significant change in revenue recognition as a result of the new standard, the implementation effort will be considerable.
Ind AS 115 requires an entity to focus on the customer’s point of view to decide revenue recognition. It prescribes a five-step model for revenue recognition.
- Identify the contract(s) with a customer: Contracts may be written, oral or implied by customary business practices, but revenue can be recognised only on those contracts that are enforceable and have commercial substance.
- Identify the separate performance obligations in the contract: Performance obligations are explicitly or implicitly promised goods or services in a contract, as well those arising out of customary business practices. An entity needs to identify performance obligations which are distinct.
- Determine the transaction price: The transaction price is the amount of consideration to which an entity expects to be entitled. It includes variable consideration, impact of significant financing components, fair value of non-cash consideration and impact of consideration payable to the customer.
- Allocate the transaction price to the separate performance obligations: The standard requires allocation of the total contract price to the various performance obligations based on their relative standalone selling prices, with limited exceptions.
- Recognise revenue when (or as) the entity satisfies a performance obligation: Revenue recognition can occur either over time or at a point in time. Revenue recognition for a performance obligation occurs over time only if it meets one of the three prescribed criteria. Ind AS 115 focuses on the ‘control approach’ to determine revenue recognition as against the ‘risk and rewards’ model under Ind AS 18.
The new standard also provides explicit guidance around certain critical key areas such as multiple element contracts, performance obligations including whether customer receives a standalone benefit, revenue recognition at a point in time versus overtime, principal versus agent, licences, warranties, sales return, variable consideration in the contract, non-cash consideration, bill and hold arrangements, contract modification, etc. There are certain key areas that normally have an effect on a company’s impact study (see graphic).
Ind AS 115 prescribes extensive qualitative and quantitative disclosures. Two of these disclosures—disclosures for remaining performance obligations and disaggregation of revenue—may be particularly challenging for companies. These disclosures will also bring in additional transparency in the financial statements.
Ind AS 115 requires retrospective application. It permits either ‘full retrospective’ adoption in which the standard is applied to all of the periods presented or a ‘modified retrospective’ adoption. Entities that elect the ‘modified retrospective’ method will not restate financial information for the comparative period. However, this does not imply that entities can ignore past revenue contracts. Rather, they will be required to calculate cumulative catch-up impact on all open contracts and make adjustment to the retained earnings as on April 1, 2018. In addition, they must disclose the amount by which each financial statement line is impacted due to Ind AS 115 application in the current period for the year ended March 2018. This will require entities to maintain two accounting records in the year of adoption—one as per Ind AS 115 and the other as per Ind AS 11 and/or 18 to comply with the disclosure requirement.
By Devesh Prakash, Associate Partner, Financial Accounting Advisory Services (FAAS), EY India.