Revenue from Contracts and Other Ind AS — Practice

Question 1

A company signs a legally binding contract to sell goods to a customer, but the customer is in significant financial distress and there is genuine doubt about its ability to pay. Explain whether Ind AS 115's Step 1 is satisfied, and what this means for revenue recognition.

Accepted Answer

Step 1 of Ind AS 115 requires, among other criteria, that it is probable the entity will collect the consideration to which it will be entitled in exchange for the goods or services transferred; a legally binding, signed contract alone is not sufficient if this collectibility criterion is not met. Given the customer's significant financial distress and the genuine doubt about its ability to pay, this criterion is not satisfied, meaning the contract does not qualify as a contract under Ind AS 115's Step 1 despite being legally valid and signed. The practical consequence is that the entity cannot apply the five-step revenue recognition model to this arrangement at all until the collectibility criterion is met, or one of the specific circumstances allowing limited recognition applies (such as the consideration received being non-refundable and the entity having no remaining obligations); revenue would instead typically only be recognised, if at all, to the extent of any non-refundable consideration actually received, or upon collectibility becoming probable, rather than being recognised in the ordinary course as goods are transferred.

Question 2

A software company sells a licence to use its accounting software for 3 years, bundled with mandatory technical support and updates for the same 3-year period, at a single combined price. Explain how many performance obligations this arrangement likely contains, and the reasoning.

Accepted Answer

This arrangement likely contains two distinct performance obligations: the software licence itself, and the technical support and updates service. Applying the distinctness test, the customer can benefit from the software licence on its own or together with other readily available resources (the software has standalone functionality even without ongoing support), and can separately benefit from the technical support and update service; the promise to provide each is also separately identifiable, since the support and update service is not so highly integrated with, or significantly modifying, the software licence itself that the two cannot reasonably be viewed as separate promises within the contract. Because both distinctness criteria, capable of benefiting the customer separately and being separately identifiable within the contract, are satisfied for each of the two promises, the transaction price should be allocated between them based on their relative standalone selling prices, with the licence typically recognised at a point in time (when control of the licence transfers) and the support and update service recognised over time (as the service is provided over the 3-year period), rather than both being recognised together as a single combined performance obligation at one point in time.

Question 3

A company sells goods for ₹100 lakh, with a contractual clause entitling the customer to a 5% rebate if it purchases a further ₹50 lakh of goods within the next quarter. Based on historical experience, the company estimates an 80% probability the customer will qualify for the rebate. Explain how the transaction price should be determined, applying the variable consideration constraint.

Accepted Answer

The rebate is variable consideration, since the ultimate transaction price depends on whether the customer achieves the further purchase threshold, and Ind AS 115 requires an entity to estimate variable consideration using either the expected value method or the most likely amount method, whichever better predicts the consideration the entity will be entitled to, and then to include that estimate in the transaction price only to the extent it is highly probable that a significant reversal of cumulative revenue recognised will not subsequently occur when the uncertainty is resolved. Using the most likely amount approach here, since the outcome is essentially binary (rebate achieved or not), the most likely outcome, an 80% probability of qualifying, would suggest a most-likely-amount estimate that the rebate will apply, given 80% comfortably clears a 'more likely than not' bar; however, before including the reduced transaction price reflecting the rebate, the company must also apply the constraint, considering whether historical experience with this specific customer and rebate structure gives sufficient confidence that a significant revenue reversal will not occur. If the constraint is satisfied, the transaction price is reduced by the expected 5% rebate; if there is meaningful residual uncertainty even at an 80% probability, given the rebate could still represent a significant amount relative to total consideration, a more conservative, constrained estimate, or continued full-price recognition with a separate refund liability recognised for the estimated rebate, would be the more defensible treatment, illustrating that the constraint operates as a genuine check on the initial estimate, not a mechanical rubber stamp of whatever probability-weighted figure is computed first.

Question 4

A specialist contractor builds a custom-designed manufacturing facility on the customer's own land, under a contract giving the contractor an enforceable right to payment for work completed to date, even if the customer were to terminate the contract for reasons other than the contractor's non-performance. The facility, being custom-designed for this specific customer's process, would have no practical alternative use to the contractor if the contract were terminated. Determine whether revenue should be recognised over time or at a point in time, and state which of the three over-time criteria is satisfied.

Accepted Answer

Revenue should be recognised over time. Of the three criteria that, if any one is met, require over-time recognition, this scenario satisfies the third: the asset created (the manufacturing facility) has no alternative use to the entity, given it is custom-designed specifically for this customer's process and could not practically be redirected to another customer without significant rework or loss of value, and the entity has an enforceable right to payment for performance completed to date, meaning the contractor is entitled to be compensated for the work and costs incurred so far (plus a reasonable margin) even if the customer terminates the contract for reasons unrelated to the contractor's own non-performance. Because both conditions of this third criterion, no alternative use and an enforceable right to payment for performance to date, are satisfied together, revenue is recognised over time as the facility is constructed, typically measured using an appropriate method of measuring progress toward complete satisfaction of the performance obligation, such as costs incurred to date relative to total expected costs, rather than being deferred entirely until the facility is finally handed over to the customer at a single point in time.

Question 5

A company sells equipment to a customer for ₹50 lakh, with payment due 2 years after delivery, and the cash price the customer would have paid if payment were made at delivery is ₹42 lakh. Explain how this arrangement should be treated under Ind AS 115, and why the full ₹50 lakh is not recognised as revenue at the point of delivery.

Accepted Answer

The difference between the deferred payment amount of ₹50 lakh and the ₹42 lakh cash price at delivery reflects a significant financing component, since the timing of payment agreed in the contract provides the customer with a significant financing benefit, effectively the company is extending credit to the customer over the 2-year deferral period. Ind AS 115 requires the transaction price to be adjusted for the time value of money where the contract includes a significant financing component, meaning revenue from the sale of the equipment itself is recognised at the cash price of ₹42 lakh at the point control of the equipment transfers to the customer, not the full ₹50 lakh nominal amount ultimately received. The difference of ₹8 lakh (₹50 lakh − ₹42 lakh) is recognised separately as interest income over the 2-year period during which the customer's payment is outstanding, using the effective interest method, reflecting that this portion of the total cash eventually received compensates the company for financing the customer's deferred payment, not for the equipment itself, and recognising the full ₹50 lakh as revenue at delivery would overstate revenue from the sale and fail to separately recognise the genuine financing income embedded within the arrangement.

Question 6

Company A contributes 10% of each employee's salary to a pension fund each year, with no further obligation once the contribution is made and the fund's investment performance risk borne entirely by the employees. Company B promises employees a pension equal to a fixed percentage of their final salary at retirement, with Company B bearing the risk of ensuring the fund can pay this promised amount regardless of investment performance. Classify each plan and state the accounting consequence of the classification.

Accepted Answer

Company A operates a defined contribution plan, since its legal or constructive obligation is limited to the amount it agrees to contribute, 10% of salary, with no further obligation once that contribution is made, and the risk that plan assets will be insufficient to pay adequate future benefits rests entirely with the employees; the accounting consequence is straightforward, with Company A simply recognising the contribution as an expense in the period the related employee service is rendered, with no further actuarial computation or liability recognised. Company B operates a defined benefit plan, since Company B itself bears the actuarial risk (that the pension promised will cost more than expected, due to factors like unexpected longevity) and investment risk (that plan assets will not generate a sufficient return) associated with delivering the promised final-salary-based pension; the accounting consequence is materially more complex, requiring an actuarial valuation to determine the present value of the defined benefit obligation, recognition of current and past service cost and net interest in profit or loss, and recognition of actuarial gains and losses in other comprehensive income, never subsequently reclassified to profit or loss, reflecting the genuinely open-ended risk Company B has retained under this plan design.

Question 7

A company receives a government grant of ₹20 lakh toward the cost of a machine costing ₹100 lakh, useful life 10 years, straight-line depreciation. Show the two alternative presentation methods Ind AS 20 permits, and the depreciation charge each produces in Year 1.

Accepted Answer

Method 1, deferred income presentation: the machine is recognised at its full cost of ₹100 lakh, depreciated over 10 years on a straight-line basis, giving annual depreciation of ₹10 lakh; the ₹20 lakh grant is separately recognised as deferred income and released to profit or loss on a systematic basis over the same 10-year period the asset is depreciated, giving grant income of ₹2 lakh per year, so Year 1 shows depreciation expense of ₹10 lakh and grant income of ₹2 lakh, a net charge of ₹8 lakh. Method 2, deduction from asset cost: the machine's carrying amount is reduced by the grant to a net cost of ₹100 lakh − ₹20 lakh = ₹80 lakh, depreciated over 10 years on a straight-line basis, giving annual depreciation of ₹8 lakh, with no separate grant income line recognised at all, so Year 1 shows depreciation expense of ₹8 lakh directly, with no offsetting income line. Both methods produce the same net effect on profit or loss each year, ₹8 lakh net charge, but differ in gross presentation — showing depreciation and grant income as two separate lines under Method 1, versus a single, already-net depreciation figure under Method 2 — and Ind AS 20 permits either presentation as a genuine accounting policy choice, to be applied consistently.

Question 8

A dairy farming company holds a herd of milking cows, which it measures at fair value less costs to sell under Ind AS 41. During the year, the herd's fair value less costs to sell increases from ₹40 lakh to ₹48 lakh, and the company also harvests milk during the year, which it sells shortly after harvest. Explain how the herd's value change and the harvested milk should each be accounted for.

Accepted Answer

The ₹8 lakh increase in the fair value less costs to sell of the milking cow herd (a biological asset) is recognised directly in profit or loss for the period, since Ind AS 41 requires biological assets to be measured at fair value less costs to sell both at initial recognition and at each subsequent reporting date, with all such changes recognised in profit or loss, rather than through OCI or held at historical cost; this reflects the standard's view that fair value changes in actively managed biological assets represent genuine period performance, not merely unrealised holding gains to be deferred. The milk harvested from the herd is agricultural produce, and is measured at its fair value less costs to sell at the point of harvest; this fair-value-less-costs-to-sell figure at harvest then becomes the milk's cost for subsequent accounting purposes, at which point the milk, no longer a biological asset itself but harvested produce, is accounted for as ordinary inventory under Ind AS 2, at the lower of this cost (established at harvest) and its NRV at each subsequent measurement date, until it is sold shortly afterward.

Question 9

A contract bundles a machine (standalone selling price ₹80 lakh) with a 2-year maintenance service (standalone selling price ₹20 lakh) for a combined contract price of ₹90 lakh. Allocate the transaction price to each performance obligation.

Accepted Answer

Total standalone selling prices = ₹80 lakh + ₹20 lakh = ₹100 lakh. The contract price of ₹90 lakh reflects an overall discount of ₹10 lakh relative to the sum of standalone selling prices, and Ind AS 115 requires this discount to be allocated proportionately across all performance obligations based on their relative standalone selling prices, unless there is observable evidence the discount relates entirely to one or more, but not all, of the performance obligations. Machine's allocated price = ₹90 lakh × (80/100) = ₹72 lakh. Maintenance service's allocated price = ₹90 lakh × (20/100) = ₹18 lakh. The machine's ₹72 lakh is recognised as revenue at the point in time control transfers to the customer, while the maintenance service's ₹18 lakh is recognised over the 2-year service period as that service is provided, typically on a straight-line basis absent evidence of a different pattern of transfer.

Question 10

A company recognised a ₹15 lakh government grant as deferred income two years ago, of which ₹6 lakh has already been released to profit or loss. This year, the government determines the company has breached a grant condition and the entire grant becomes repayable. Explain how this repayment obligation should be accounted for.

Accepted Answer

Ind AS 20 treats a grant that becomes repayable as a change in accounting estimate, accounted for prospectively rather than by restating prior periods. The repayment is first applied against any remaining unamortised deferred income balance relating to that grant, here ₹15 lakh − ₹6 lakh = ₹9 lakh, which is extinguished against the repayment obligation; any excess of the repayment amount over the remaining deferred income balance, here ₹15 lakh repayable minus ₹9 lakh remaining deferred income = ₹6 lakh, is recognised immediately as an expense in the current period. This treatment reflects that the ₹6 lakh already recognised as income in earlier periods, when the entity reasonably expected to retain the grant, does not get retrospectively reversed out of those prior periods' figures, but the current obligation to repay the full amount must still be recognised in full through a combination of extinguishing the remaining deferred income and expensing the shortfall.

Question 11

A media company licenses its brand and logo to a manufacturer for use on merchandise for 3 years, and the licence agreement requires the media company to continue actively promoting and evolving the brand throughout the licence period, with the value of the licence to the manufacturer directly affected by that ongoing promotional activity. Explain whether revenue from this licence should be recognised at a point in time or over time, and why.

Accepted Answer

Ind AS 115 distinguishes a licence providing a right to access the entity's intellectual property as it exists throughout the licence period, recognised over time, from a licence providing a right to use the entity's intellectual property as it exists at a point in time, recognised at that point. The distinguishing factor is whether the entity's ongoing activities significantly affect the intellectual property, and whether the customer is exposed to the positive or negative effects of those ongoing activities. Here, since the licence agreement requires the media company to continue actively promoting and evolving the brand, and the manufacturer's licence value is directly affected by that ongoing activity, this is a right-to-access licence, and revenue should be recognised over time, over the 3-year licence period, reflecting the ongoing nature of the value being delivered, rather than being recognised entirely at the point the licence agreement is signed or the brand assets are initially made available, which would be appropriate only for a right-to-use licence where the intellectual property's value to the customer is fixed as of a specific point and unaffected by the licensor's subsequent activities.

Question 12

A company's defined benefit obligation has a present value of ₹200 lakh, and plan assets have a fair value of ₹150 lakh, at the start of the year. The discount rate used to measure the obligation is 8%. Compute the net interest expense recognised in profit or loss for the year, and state where this differs from actuarial gains and losses arising from remeasurement.

Accepted Answer

Net defined benefit liability at the start of the year = Present value of obligation ₹200 lakh − Fair value of plan assets ₹150 lakh = ₹50 lakh. Net interest expense = Net defined benefit liability × discount rate = ₹50 lakh × 8% = ₹4 lakh, recognised in profit or loss for the year, reflecting the unwinding of the discount on the net obligation over time, computed using the same discount rate used to measure the obligation itself at the start of the period. This net interest component is recognised in profit or loss and differs from actuarial gains and losses, which arise from remeasurements of the defined benefit obligation (due to changes in actuarial assumptions or experience adjustments) and of plan assets (the difference between actual return on plan assets and the amount already included in net interest); these remeasurement components are recognised in other comprehensive income, never subsequently reclassified to profit or loss, reflecting Ind AS 19's deliberate separation between the relatively predictable, systematic net interest cost recognised in profit or loss and the genuinely volatile, estimate-driven remeasurement components kept in OCI.

Question 13

A manufacturer sells goods to a retailer and separately pays the retailer a ₹5 lakh 'slotting fee' to secure premium shelf placement for its products. Explain how this payment should be treated in relation to the transaction price for the goods sold, unless the payment is for a distinct good or service received from the retailer.

Accepted Answer

Ind AS 115 requires consideration payable to a customer to be accounted for as a reduction of the transaction price, and therefore of revenue, unless the payment is in exchange for a distinct good or service that the customer transfers to the entity, in which case it is accounted for in the same way the entity accounts for other purchases from suppliers. Here, the ₹5 lakh slotting fee paid to secure shelf placement is not, on these facts, described as being in exchange for a distinct good or service the retailer provides back to the manufacturer separate from the retailer's ordinary role as a purchaser and reseller of the goods; absent evidence that the fee corresponds to a distinct, separately identifiable service the retailer performs (such as a genuinely separate, fair-value marketing service), the ₹5 lakh payment should be treated as a reduction of the transaction price for the goods sold to the retailer, reducing the manufacturer's recognised revenue rather than being recognised as a separate marketing or selling expense.

Question 14

A company pays a ₹4 lakh sales commission to its salesperson for successfully securing a 4-year customer contract. Explain whether this cost should be expensed immediately or capitalised, and if capitalised, how it should be subsequently recognised.

Accepted Answer

Ind AS 115 requires the incremental costs of obtaining a contract, costs that would not have been incurred if the contract had not been obtained, to be recognised as an asset if the entity expects to recover those costs, unless the entity applies the practical expedient available for contracts with an amortisation period of one year or less, which does not apply here given the 4-year contract term. Since the ₹4 lakh sales commission is incremental (it would not have been paid absent successfully securing this specific contract) and the entity presumably expects to recover it through the margin earned on the contract, it should be capitalised as an asset rather than expensed immediately. This capitalised asset is then amortised on a systematic basis consistent with the transfer of the goods or services to which the asset relates, meaning the ₹4 lakh commission is spread as an expense across the 4-year contract period, generally in a pattern that corresponds with how the related revenue is recognised over that same period, rather than being expensed entirely in the period the commission is paid, which would mismatch the cost of obtaining the contract against the revenue that contract is expected to generate over its full term.

Question 15

A company decides to offer a voluntary redundancy package to a group of employees as part of a restructuring, and communicates this offer to affected employees on 15 March, with employees given until 15 April to accept. Explain, under Ind AS 19, when the termination benefit liability should be recognised.

Accepted Answer

Ind AS 19 requires termination benefits to be recognised at the earlier of when the entity can no longer withdraw the offer of those benefits, and when the entity recognises costs for a restructuring that involves the payment of termination benefits. For an offer made to encourage voluntary redundancy, the entity can no longer withdraw the offer once employees have accepted it, or, for an offer that remains open for a period, once the offer has been communicated to employees in a manner that creates a valid expectation and the entity is no longer able to withdraw it, which is often effectively at the point of communication if the offer is irrevocable once made, or, if the entity retains the ability to withdraw the offer at any point up to acceptance, at the point of employee acceptance. Given the offer was communicated on 15 March with a defined acceptance window, the specific facts about whether the offer is genuinely irrevocable once communicated determine the exact recognition point, but in either interpretation, recognition would occur no later than 15 April, when individual employees accept, and potentially earlier, on 15 March, if the offer, once communicated, could not be withdrawn by the company regardless of whether any given employee had yet accepted.

Practice — Revenue from Contracts and Other Ind AS

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