Ind AS 115:Revenue from Contracts with Customers||Step 3: Determining the Transaction Price

Introduction

Ind AS 115 Revenue from Contracts with Customers talks about revenue recognized in financial statements. There is a 5-step model to recognize the revenue. An entity then uses Step 3 to calculate the transaction price of the contract after identifying the contract in Step 1 and the performance obligations in Step 2. The objective of Step 3 is to predict the total amount of consideration to which the entity will be entitled from the contract.

What is the Transaction Price?

The transaction price is the amount of consideration to which an entity expects to be entitled to in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some sales taxes).

The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both and an entity shall consider the terms of the contract and its customary business practices to determine the transaction price. An entity must assume that the goods or services will be provided to the customer as promised under the terms of the current contract and that the agreement won’t be terminated, renewed, or modified in order to calculate the transaction price.

Variable Consideration

The amount of consideration to which an entity will be entitled in exchange for providing the promised goods or services to a customer must be estimated by the entity if the consideration promised in a contract includes a variable amount. An amount of consideration can vary due to discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, or other similar items. In cases where a party’s right to consideration depends on the occurrence or non-occurrence of a future event, the promised consideration may also change. For instance, some products are sold with the right to return.

Penalties may be outlined in some contracts. In such circumstances, penalties must be accounted for as per the substance of the contract. Where the penalty is inherent in the determination of transaction price, it shall form part of variable consideration. For example, where an entity agrees to transfer control of a good or service in a contact with the customer at the end of 10 days for Rs. 10,000, and if it exceeds 10 days, the entity is entitled to receive only Rs. 9,500, the reduction of Rs. 500 shall be regarded as variable consideration. In other cases, the transaction price shall be considered as fixed.

Depending on which method it believes will allow it to more accurately predict the total amount of variable consideration to which it will be entitled, an entity shall estimate the amount of variable consideration using one of the following methods:

An entity should apply one method consistently while estimating the effect of uncertainty on an amount of variable consideration to which the entity is entitled. Further, an entity should consider all information that is available for identifying a reasonable number of possible consideration amounts.

Constraining estimation of variable consideration

An entity shall include some or all of an amount of variable consideration estimated (the expected value or the most likely) in the transaction price. It is highly probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.

An entity shall take into account both the likelihood and the magnitude of the revenue reversal in determining whether it is highly probable that once the uncertainty related to the variable consideration is subsequently resolved, a significant reversal in the amount of cumulative revenue recognized will not occur. A revenue reversal could be influenced by a number of factors, including but not limited to those listed below:

• The amount of consideration is highly susceptible to factors outside the entity’s influence. Those factors may include volatility in a market, the judgement or actions of third parties, weather conditions, and a high risk of obsolescence of the promised good or service.
• The uncertainty about the amount of consideration is not expected to be resolved for a long period of time.
• The entity’s experience (or other evidence) with similar types of contracts is limited, or that experience (or other evidence) has limited predictive value.
• The entity has a practice of either offering a broad range of price concessions or changing the payment terms and conditions of similar contracts in similar circumstances.
• The contract has a large number and broad range of possible consideration amounts.

Significant Financing Component

An entity shall adjust the promised amount of consideration for the effects of the time value of money if the timing of payments agreed to by the parties to the contract (either explicitly or implicitly) provides the customer or the entity with a significant benefit of financing the transfer of goods or services to the customer, during determining the transaction price.

When adjusting the promised amount of consideration for a significant financing component, the objective is for an entity to recognize revenue at a level that corresponds to the price that a customer would have paid for the promised goods or services if the customer had made a cash payment at the time (or as) they transferred to the customer (i.e. the cash selling price). An entity shall consider all relevant facts and circumstances in assessing whether a contract contains a financing component and whether that financing component is significant to the contract, including both of the following:

• the difference, if any, between the amount of promised consideration and the cash selling price of the promised goods or services(promise consideration- cash Selling price= Finance components); and
• the combined effect of both of the following:

o the expected length of time between when the entity transfers the promised goods or services to the customer and when the customer pays for those goods or services; and
o the prevailing interest rates in the relevant market.

To meet the objective, when adjusting the promised amount of consideration for a significant financing component, an entity shall use the discount rate that would be reflected in a separate financing transaction between the entity and its customer at contract inception. That rate would reflect the credit characteristics of the party receiving financing in the contract, as well as any collateral or security provided by the customer or the entity, including assets transferred in the contract. An entity may be able to determine that rate by identifying the rate that discounts the nominal amount of the promised consideration to the price that the customer would pay in cash for the goods or services when (or as) they transfer to the customer. After contract inception, an entity shall not update the discount rate for changes in interest rates or other circumstances (such as a change in the assessment of the customer’s credit risk).

Non-Cash Consideration

To determine the transaction price for contracts in which a customer promises consideration in a form other than cash, an entity shall measure the non-cash consideration (or promise of non-cash consideration) at fair value.

If an entity cannot reasonably estimate the fair value of the non-cash consideration, the entity shall measure the consideration indirectly by reference to the stand-alone selling price of the goods or services promised to the customer (or class of customer) in exchange for the consideration. 

Consideration payable to a Customer 

Consideration payable to a customer includes cash amounts that an entity pays, or expects to pay, to the customer. Consideration payable to a customer also includes credit or other items (for example, a coupon or voucher) that can be applied against amounts owed to the entity (or to other parties that purchase the entity’s goods or services from the customer). An entity shall account for consideration payable to a customer as a reduction of the transaction price and, therefore, of revenue unless the payment to the customer is in exchange for a distinct good or service that the customer transfers to the entity. If the consideration payable to a customer includes a variable amount, an entity shall estimate the transaction price.

An entity must account for the purchase of a specific good or service from a customer in the same way that it accounts for other purchases from suppliers if the consideration due to the customer is payment for that specific good or service. If the consideration due from the customer is greater than the fair market value of the particular good or service that the entity receives from the customer, the excess must be deducted from the transaction price. The entity must account for all of the consideration due to the customer as a reduction of the transaction price if it is impossible for it to reasonably estimate the fair value of the good or service received from the customer.

Accordingly, if consideration payable to a customer is accounted for as a reduction of the transaction price, an entity shall recognize the reduction of revenue when (or as) the later of either of the following events occurs:

• the entity recognizes revenue for the transfer of the related goods or services to the customer; and
• the entity pays or promises to pay the consideration (even if the payment is conditional on a future event). That promise might be implied by the entity’s customary business practices.