India will have a new revenue recognition standard outlining a single
comprehensive model for entities to use in accounting for revenue arising from
contracts with customers. This supersedes most current revenue recognition
standard.
In brief, the new standard seeks to streamline, and remove
inconsistencies from, revenue recognition requirements; provide a more robust
framework for addressing revenue issues; make revenue recognition practices
more comparable; and increase the usefulness of disclosures.
Introduction
The Government has introduced two
significant game-changers to financial reporting standards in 2018 to effective
communication to investors by corporates.
International Financial Reporting
Standards (IFRS) accounting framework replaces extant revenue and lease
standards effective financial periods commencing from January 1, 2018. Both the
new standards have a significant impact on financial statements for majority of
sectors. Indian companies too have to brace up for the new Indian Accounting
Standards (IND-AS) on revenue that would go live shortly.
The International Accounting
Standards Board (IASB), as part of a joint convergence project with its United
States Counterpart, the Financial Accounting Standards Board (FASB) has
re-modeled the revenue recognition guidance. The new IFRS 15 - Revenue From
Contracts With Customers replaces prevailing IAS's and related interpretations,
primary of them being (1) IAS 11- Construction Contracts and (2) IAS 18 –
Revenue. A new principle for revenue recognition has emerged with the emphasis
on the concept of transfer of control and a detailed accounting model, it has
been launched as the Five Step Revenue Recognition Model and is to be followed
for every revenue contract to account for the financial statement reporting
consequences.
“IFRS 15 Revenue from
Contracts with Customers provides a single revenue recognition model based
on the transfer of control of a good or service to a customer. The new revenue
standard marks a significant change from current requirements under IFRS. It
provides a more structured approach to measuring and recognising revenue, with detailed
application guidance. Therefore, adoption may be a significant undertaking for
many entities. Early assessment will be key to managing a successful
implementation.”
Evaluation of contracts, customer
agreements, pricing models, side-arrangements, revenue and delivery models,
contractual clauses, underlying economics, deliverables analysis, et al, become
very critical as companies’ transition to the new revenue recognition standard.
Standard operating procedures and
internal controls also need to be geared up and fine-tuned to comply with this
critical financial reporting standard.
The Exposure Draft on
clarifications to Ind AS 115 proposes that Ind AS 115 would be applicable for
accounting periods beginning on or after 1st April, 2018. The MCA is
expected to notify the standard soon.
The effect on entities will vary,
and some may face significant changes in revenue recognition. Entities should
now be assessing how they will be affected so they can prepare an
implementation plan for the new standard.
Core Principle of Revenue
Recognition Changes
The global reporting standard
moves from a "transfer of risks and rewards" model to a
"transfer of control" model. This model determines the timing of
revenue recognition. The new timing is when there is a transfer of control of
promised deliverable by the seller (reporting entity).
The core principle of the new
revenue standard under both IFRS and United States Generally Accepted
Accounting Principles (USGAAP) is that an entity recognized revenue to depict
the transfer of promised goods and services to customers in an amount that
reflects the consideration to which it expects to be entitled in exchange for
such promised goods and services. Henceforth, revenue needs to be recognized
upon transfer of control of promised products or services to customers in an
amount that reflects the consideration that the entity expects to receive in
exchange for those products or services.
Where a company enters into
contracts that could include various combinations of products and services, the
company needs to isolate the various revenue components, based on whether each
component is generally capable of being distinct and accounted for as separate
performance obligations. IFRS reporting entities need to follow a detailed
5-step model to account for revenue as follows.
Step 1 - Identify the
contract with the customer
Step 2 - Identify the
performance obligations in the contract
Step 3 - Determine the
transaction price
Step 4 - Allocate the
transaction price to the separate performance obligations in the contract
Step 5 - Recognize revenue
when or as the reporting entity satisfies a performance obligation
Revenue Recognition Principle
Application – The Granularities
A contract is an agreement
between two or more parties that creates enforceable rights and obligations and
includes promises to transfer goods or services to a customer. Where such
goods/services spelled out in the contract are distinct, the promises are
performance obligations and are accounted for separately. A good or service is
distinct if the customer can benefit from the good or service on its own or
together with other resources that are readily available to the customer, and
the seller's promise to transfer the goods or services to the customer is
separately identifiable from other promises in the contract.
Further, the transaction price
needs to be adjusted for the effects of the time value of money if the contract
includes a significant financing component and for any consideration payable to
the customer under the contractual terms. Where the consideration is variable,
the entity is required to estimate the amount of consideration to which it will
be entitled to in exchange for the promised goods or services.
The transaction price is to be
allocated to each performance obligation on the basis of the relative stand
alone selling price of each distinct good or service promised to the customer.
Revenue is to be recognized as and when as the company satisfies a performance
obligation by transferring a promised good or service to a customer, which is
when the customer obtains control of that good or service.
Conclusion
The impact of the new Ind AS revenue
standard extends far beyond the finance function. The new revenue standard
marks a significant change from current requirements under IFRS. It provides a
more structured approach to measuring and recognising revenue, with detailed
application guidance. Therefore, adoption may be a significant undertaking for
many entities. Early assessment will be key to managing a successful
implementation.
For more detail:
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Acquisory News Chronicle February 2018
