by Recognition and identifying performance obligation
An entity should assess the goods or services promised in a contract and identify as a performance obligation each promise to transfer either:
- Good or service or
- A series of distinct goods or service that are similar and have the same pattern of transfer
Contract with the customer can include promises that are implied by an entity’s business practice apart from those explicitly stated in the contract. Performance obligation does not include activities undertaken an entity to execute the contract which does not result in a transfer of goods or services.
Distinct Goods or Services
Goods or services that are promised to a customer are distinct if both the conditions are met:
Distinct goods or services include the following:
Sale of goods produced by an entity
- Resale of goods produced by an entity
- Performing a contractually agreed-upon task
- Resale of rights to goods or services purchased by an entity
- Constructing, manufacturing or developing an asset on behalf of a customer etc
Goods or services (not distinct) can be combined with other goods or services and in some cases, an entity might account for all the goods or services in a contract as a single performance obligation.
Satisfaction of Performance Obligation
Revenue should be recognised when (or as) the entity satisfies a performance obligation by transferring a promised goods or services to a customer (customer obtains control). For each performance obligation, an entity should determine the following:
Goods and services are assets even when they are received and used momentarily. Control over an asset is the ability to direct the use of and obtain substantially all of the remaining benefits from the asset. To evaluate whether the customer has the control over an asset, the entity should consider any agreement or repurchase the asset.
Measuring progress of satisfaction: Revenue Recognition
Each per performance obligation satisfied over time, revenue should be recognised by measuring the progress of complete satisfaction at the end of every reporting period. An entity should use the single method consistently for such measurement.
Two types of methods used are input method and output method which an entity should consider based on the nature of the goods or services. Following points to be noted:
- When applying method, excluding goods or services for which control is not transferred.
- Update the measure of progress to reflect any changes in the performance obligation outcome.
- Recognise revenue only if the entity can reasonably measure its progress, if not recognise only the cost incurred.
Measurement
An entity shall recognise the amount of allocated transaction price as revenue once a performance obligation is satisfied. Transaction price which can be fixed or variable amount is determined based on the terms of contract and entity’s customary practice.
a) Variable Consideration
If the consideration includes a variable amount, an entity should estimate the amount of consideration to which it will be entitled in exchange for transferring the promised goods or services to a customer. Estimation can be done using any of the two methods being:
The expected Value: The sum of probability-weighted amounts in a range of possible consideration
The Most Likely Amount: Single most likely outcome of the contract
b) Constraining estimates of Variable Consideration
In assessing the uncertainty related to variable consideration, an entity should consider both the likelihood and the magnitude of revenue reversal. Following are the factors that indicate the high probability of revenue reversal related to the amount of consideration:
- High susceptibility to factors outside entity’s control
- Uncertainty exists and it’s expected to resolve for a long time
- Entity’s experience has limited predictive value
- Has a large range of possible consideration amounts etc.
c) The existence of a significant financing component
In determining the transaction price, an entity should adjust the promised amount of consideration for the time value of money if significant financing components exist.
In assessing if a contract contains a significant financing component; an entity should consider the relevant facts including both of the following:
- Difference between the amount of promised consideration and the cash selling price of the goods or services.
- The combined effect of the prevailing interest rate in the market and expected length of time between when the transfer of goods or services and the time when the customer makes the payment.
d) Non-Cash Consideration
When customer promises to pay consideration other than in cash form, an entity should measure it at fair value. If fair value cannot be reasonably measured, then entity should measure the consideration indirectly by reference to the stand-alone selling price of the goods or service in exchange for consideration.
e) Consideration payable to Customer
Consideration payable to the customer includes cash amounts, credits or other items (voucher or coupon) and entity account it as a reduction of transaction price (revenue). An entity should recognise the reduction of revenue when (or as) either of the following events occurs:
- Recognises revenue for the transfer of related goods or service to the customer
- Pays or promises to pay the consideration
Allocation of Transaction Price to Performance Obligation
Entity should allocate the transaction price to each performance obligation identified in a contract on a relative stand-alone selling price basis (It is the price at which an entity would sell a promised good or service separately to a customer). If this price is directly not available, it should be estimated using methods such as:
The adjusted market assessment approach
- Expected cost plus margin approach
- Residual approach
- Contract Cost
Incremental cost of obtaining a contract with a customer – Entity should recognise as an asset if the entity expects to recover those costs. These are expenses which an entity would not have incurred if the contract had not been obtained (eg. sales commission)
Cost to fulfil a contract: Entity should recognise an asset from the cost incurred to fulfil a contract if those costs:
- Relate directly to a contract that an entity can specifically identify
- Generate or enhance resources of the entity used in satisfying the performance obligation in future.
- Is expected to recover
