Indian GAAP requires that revenue should be measured by the charges made to the customer. IAS 18 requires that revenue should be measured at the fair value of the consideration received or receivable from the customer. It stipulates that if the payment is deferred and the time value is material, fair value of the consideration is the present value (PV) of the consideration determined using the imputed interest rate as the discount rate. The imputed rate of interest is the more clearly determinable of either: the interest rate at which the customer could borrow from the market at the same terms and conditions; or a rate of interest that discounts the nominal amount of the consideration to the current cash sales price of the goods or services. Application of the principles stipulated in IAS-18 gives a result different from the result that is obtained by applying the principles stipulated in the Indian GAAP. For example, a dealer sells diesel to companies that own tea gardens at the regulated price. Although, as per the contract, the dealer does not extend any credit, usually those companies pay the amount after nine months. The dealer sells diesel to retail customers on cash basis at the same regulated price. Under the Indian GAAP the dealer recognises revenue at the nominal amount of the consideration received or receivable from tea companies. Under IFRS, the dealer should recognise the revenue from sales of goods at the PV of the cash received or receivable and it should recognise the difference between the PV and the nominal amount at the interest income. This is so because, in substance, the dealer implicitly extends a line of credit to tea companies.
The Exposure Draft (ED) issued by the IASB on ‘Revenue from contracts with customers’ stipulates that the revenue should be measured at the transaction price. The transaction price reflects the probability-weighted amount of consideration that an entity expects to receive from the customer. In other words, the entity should assess the credit risk at the inception of the transaction. For example, if an entity, based on experience, estimates that there is 10 per cent chance that the buyer will not pay the consideration, it will measure the revenue from a sale invoiced at Rs. 1,000 at Rs. 900 (1,000 × .90 + 0 × .10). If, subsequently the customer pays an amount higher or lower than Rs. 900, the difference will be recognised as a gain or loss in the profit and loss account.
The ED stipulates that in determining the transaction price, an entity should adjust the amount of promised consideration to reflect the time value of money if the contract includes a material financing component (whether implicitly or explicitly). The entity should separate the financing transaction by discounting the amount of promised consideration by a rate that reflects both the time value of money and credit risk. Application of these principles will give the same results as that is obtained by the application of the principles stipulated in IAS 18, if the entity extends credit for a reasonably long period (usually, six months or more) or from experience the entity estimates that the customer will pay after a reasonably long period. However, the principles stipulated in the ED will change the accounting for advance or progress payments received from a customer.
We may take the examples of development of residential property. The developer satisfies the performance obligation on delivery of the apartment because the buyer obtains control over the same only on delivery. The developer receives progress payments over the construction period, which is reasonably long. Therefore, the contract between the developer and the buyer includes a material financing component. According to the ED, revenue should be recognised at the PV of the consideration received in advance. The discount rate should reflect the time value of money and the credit risk of the developer.
We may expect significant changes in the accounting for recognition of revenue. Although the element of estimate will increase in measurement of revenue, the proposed accounting principles will improve the presentation of income in the profit and loss account. Proposed accounting principles focus on the substance of the contract. With increase in the element of estimate in measurement, the responsibility of the audit committee will also increase.
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