IND AS 115 – 5 Step Model for Revenue Recognition

IND AS 115 – 5 Step Model for Revenue Recognition

IND AS 115 - 5 Step Model for Revenue Recognition

On March 28, 2018, the Ministry of Corporate Affairs (MCA) notified Ind AS 115, a new Financial Reporting Standard for revenue recognition that replaces existing Ind AS 11 and Ind AS 18. This financial reporting standard, based on IFRS 15, creates a single model for recognizing revenue from contracts with customers.

The main objective of this financial reporting standard is to provide users of financial statements with useful information about:

  • The nature, amount, timing, and uncertainty of revenue
  • Cash flows arising from a contract with a customer

To achieve this objective, the core principle of this financial reporting standard is that an entity recognizes revenue to reflect:

  • The transfer of promised goods or services to customers
  • The consideration the entity expects to receive in exchange for those goods or services

Ind AS 115 follows a five-step model for revenue recognition:

  1. Identify the contract
  2. Identify performance obligations
  3. Determine the transaction price
  4. Allocate the transaction price
  5. Recognize revenue when (or as) a performance obligation is satisfied

This step verifies if a valid contract exists, with the customer’s approval, including clear rights, payment terms, commercial substance, and a high probability of collecting due consideration.

Company A faces liquidity issues. Company B promises goods in exchange for a Letter of Credit (LC). Company B completes the order but hasn’t received the LC. When should Company B recognize revenue?

In this case, due to the uncertainty of collecting payment, revenue recognition wouldn’t happen until the LC is received, fulfilling the “probable collection” requirement of Ind AS.

Identify distinct goods or services promised in the contract and assess if each represents a performance obligation to be satisfied by transferring control to the customer.

  • NJ Ltd. contracts to build a house for a customer, including architectural design, site preparation, construction, plumbing, electrical, and finishing carpentry.
  • In this case, the overall promise is to deliver a complete house, where individual goods/services are inputs. So, they should be combined into a single performance obligation.

  • The transaction price is the expected earnings from transferring goods/services to the customer, excluding third-party amounts like GST. It can involve fixed and variable components.
  • Calculate this price assuming the transfer happens as per the contract without cancellations, renewals, or changes.

  • A car dealership sells a car for Rs. 20,00,000 with a warranty offering free repairs for the first year. They estimate the warranty cost at Rs.1,00,000.
  • The car dealership determines that the transaction price is Rs. 20,00,000, but it must adjust for the expected cost of the warranty repairs, which is estimated to be Rs.1,00,000.

This step allocates the transaction price to each performance obligation based on the expected consideration for fulfilling that specific obligation.

An airline sells a round-trip flight from Mumbai to Delhi for Rs. 30,000, including a meal and a checked bag. They estimate standalone selling prices:

  • Flight: Rs. 24,000
  • Meal: Rs. 2,000
  • Checked bag: Rs. 4,000

The airline must allocate Rs. 24,000 for flight, Rs.2000 for meal and Rs.4000 for checked bag

  • A performance obligation is satisfied over time if it meets any of these criteria:
  • Customer consumes benefits as the entity performs
  • Customer controls an asset as it’s created or enhanced
  • Asset has no alternative use, and the entity has the right to payment for work done
  • If none are met, revenue is recognized at a specific point in time.
  • Ind AS 115 uses a control approach for revenue recognition, unlike the risk and rewards approach of Ind AS 18.

A furniture store enters into a contract with a customer to sell a couch for Rs. 100000. The contract specifies that the couch will be delivered to the customer’s home in two weeks. The furniture store recognizes revenue when the couch is delivered to the customer’s home, as that is when control of the good is transferred to the customer.

Ind AS 115, the new financial reporting standard for revenue recognition, emphasizes transparency and user-friendliness in financial statement preparation. Its disclosure requirements aim to provide the user of financial statements, with a clear picture of an entity’s revenue and cash flows.

While more detailed than previous regulations, these disclosures are not overly restrictive. They focus on presenting both quantitative and qualitative information about:

  • The nature of the entity’s revenue: What types of revenue does the company generate, and what’s their relative importance?
  • Recognition and timing: How much revenue is recognized, and when does this recognition occur for each type of revenue?
  • Uncertainties: Are there any significant uncertainties surrounding the recognized revenue and related cash flows?

The ultimate goal of Ind AS 115 is to enhance fairness and transparency in financial statement preparation. By effectively implementing and disclosing revenue information using Ind AS 115 in financial statement preparation, companies can:

  • Build trust and credibility with investors, creditors, and other stakeholders.
  • Benchmark performance more effectively against competitors who have also adopted the standard.
  • Achieve its Corporate Governance goals with Ind AS compliant financial statements.

The shift from AS to Ind AS in case of financial statement preparation entails a significant change for Indian companies, impacting financial reporting and potentially demanding adjustments to internal processes.

But don’t worry, Master Brains Consulting is here to guide you through this transition smoothly and effectively.

We assess your current accounting practices for financial statement preparation against Ind AS requirements, identifying areas needing adjustment and potential risks.

  • We quantify the potential financial and operational impact of Ind AS adoption on your company, helping you make informed decisions.
  • We develop a tailored roadmap for your Ind AS transition, considering your industry, size, and complexity.
  • We review and revise your accounting policies and procedures to ensure the preparation of Ind AS compliant financial statements.
  • We provide comprehensive training for your finance and accounts team on financial statement preparation as per Ind AS.

Contact Master Brains Consulting today for a free consultation and let us help you with Ind AS compliant financial statement preparation with ease. We are committed to providing you with the expertise, guidance, and support you need to achieve a smooth and successful transition, ultimately enhancing your financial transparency and stakeholder trust.