Revenue Recognition Services The specific circumstances under which income is recognized are determined by the accounting principle known as revenue recognition. The ICAI is the organization that issues the AS 9 Revenue Recognition. Revenues are defined by the Institute of Chartered Accountants of India as the gross inflow of cash, receivables, or other consideration that results from the sale of goods or the provision of services, as well as from various different sources like interest, royalties, and dividends, during the ordinary course of an enterprise's operations. The price clients charge for purchasing goods and services must be used to calculate revenue. Determining when a company has earned its income is known as revenue recognition. For businesses that employ accrual-basis accounting, it is different. When using the accrual approach, revenue is only recognized once it has been received. However, when there is an agency relationship, the revenue must be calculated using the commission fees. It doesn't depend on the total amount of cash, receivables, or any consideration. There are a few instances where the assertion made above calls for a specific exception: Revenue comes from construction contracts Revenue through grants and other comparable subsidies from the government. Revenue ton insurance companies from the Insurance contracts. Applicability of AS 9 Revenue Recognition This standard, released by the ICAI in 1985 and in the early years, was only needed for Level I organizations, but as of April 1st, 1993, it is now required for all organizations. According to the ICAI, an enterprise is a company as defined in Section 3 of the 2013 Companies Act. The term "Level I enterprises" refers to businesses whose turnover for the most recent accounting year exceeded Rs. 50 crores. The turnover applies to holding and subsidiary companies and excludes any other income. Explanation of Revenue Recognition Revenue Recognition emphasizes when revenue is recognized in a company's statement of profit and loss. A contract between the parties to a transaction usually specifies how much money will be made due to that transaction. The timing of the revenue may be impacted whenever uncertainty exists regarding the estimation of the amount or any of its related costs. Key Elements of Revenue Recognition The following are the key elements of revenue recognition: Sale of Goods The sale of goods is a crucial factor in deciding whether or not a transaction's revenue should be recognized. The ownership of the products has been given to the buyer in exchange for money by a seller. The transfer of key risks and rewards associated with ownership of the products frequently leads to the transfer of property in the goods. The transfer of material risks frequently does not coincide with the transfer of goods to the buyer, though. When items are transferred to the buyer in these types of situations, revenue must be recognized at that time. When substantial risks and rewards are transferred to the buyer in such cases, income must be taken at that time. For example, goods that are sent to the consignee after approval. The performance could be nearly finished before the transaction that generates money is executed in many circumstances in the industry. When a sale is guaranteed by a government guarantee, under a forward contract, or when there is a market and a small risk of failing to sell, the items are evaluated according to their net realizable value (NRV). These types of sums, such as the harvesting of agricultural crops or the extraction of mineral ores, are not specified in the definition of revenue but are occasionally noted in the statement of profit and loss. Rendering of Services The performance of the service affects how much revenue is recognized for it. This is divided further into two categories: Proportionate Completion Method: The profit and loss statement shows income in proportion to how well each service has been completed under the proportionate completion method of accounting. Here, the performance of multiple acts constitutes the accomplishment of service. Every time one of these acts is finished, the revenue is acknowledged. Completed Service Contract Method: When performing services under a contract that is finished or nearly finished, this method of accounting records revenue in the statement of profit and loss account. Dividends, Royalties and Interest The use by others of the enterprise gives rise to - Interest: Here, after accounting for the outstanding balance and the relevant rate, the revenue is recognized on a time percentage basis. For illustration: Even if the interest for the specified period from January to March will be received in June, if the interest on a fixed deposit is due on the 31st of March, the income will be recognized on the 31st of March when the books are closed. Royalties: In general, royalty includes the fee for using a trademark, a patent, or other intellectual property. According to the relevant agreement and on an accrual basis, revenue must be recognized. As an illustration, the royalty must only be recognized if it is determined by the number of book copies sold. Dividends: The revenue must be recognised when the owner's entitlement to the payments is proven. When the company decides to pay dividends to its shareholders and announces a dividend on its shares, it is inevitable. Conditions Given for Recognising Revenue The following prerequisites must be met to recognize the revenue by Indian Accounting Standards: The buyer must take the risks and rewards of ownership from the seller. The sold goods are no longer under the seller's control. It is reasonably guaranteed that the goods or services will be paid for. The amount of revenue can be measured reasonably. Revenue costs can be calculated reasonably. a) Performance refers to the Conditions mentioned in points (1) and (2). When a seller has complied with expectations and is therefore entitled to payment, this is referred to as performance. b) The third point is referred to as collectability. The seller must have a reasonable expectation that they will be paid for their work in accordance with the performance. c) The above-mentioned conditions (4) and (5) are referred to as measurability. The seller must be able to balance his income and expenses in accordance with accounting regulations. Therefore, it is necessary to fairly measure both revenues and expenses. What are the Steps in Revenue Recognition from Contracts? The five steps for revenue recognition in contracts are as follows: Identify the customer contract. You must first identify the contract you have with the customer to recognize revenue. This stage of the revenue recognition process does not always require formal contracts to be signed. Contracts can also be regarded as verbal agreements and written terms and conditions for your service or product. Every contract has a few essential requirements. It must be a business contract between two parties that outlines their rights, obligations, and payment terms. A client contract could be a formal written contract, as is frequently the case with service-based businesses, or it could be a receipt for a point-of-sale transaction at a retail store. Online purchase terms of service are frequently incorporated into invoices or subscription information, Identify the contract's specific performance obligations. You must ensure that your duties to the consumer are clear before you record income. The phrase "performance obligation" refers to items the seller has pledged to send. A "distinct" product or service typically has its line item on an invoice or receipt. A specific performance obligation in a bakery would be the verbal agreement to provide one pastry in exchange for a predetermined sum rather than the entire order. One insurance policy for a single house could be a specific performance obligation for an insurance broker. But it's not always that easy. The product or service must be distinct from the other goods or services covered by the contract for the consumer to profit from it. Consider that you are attempting to sell a vacuum to a consumer. Additionally, you sell them an additional vacuum warranty; this item has its line on the invoice. If the vacuum is required to purchase the warranty, then the warranty does not have its own "performance obligation." Determine the transaction price. The "transaction price" includes more than just the cash you exchange with a consumer for a good or service. The ability to return items or prospective discounts are examples. Always be clear about these conditions, especially if they differ from previous practice. If you provide a discount for e-commerce purchases during your semi-annual sale, the discount and the option to return or cancel the contract are included in the transaction price. The following items might be included in the transaction price, for instance, if a department store is having a clearance sale: The consumer purchases a dress that usually costs Rs.100 for Rs.25 instead, with no exchanges or refunds allowed. Refunds are typically associated with physical things, but in any service clarifying those terms is just as crucial. What happens if customers aren't happy with the service? They will be curious about their legal rights. Allocate the prices to the performance obligation. Every company must decide the precise selling price associated with each unique performance obligation. When each good or service has a separate selling price, allocating the transaction price is simple. Estimate the cost based on the expected value when there are changeable factors, such as discounts, incentives, and rebates. Recognize revenue when you've fulfilled each performance obligation. There should be no revenue recognized until your performance obligation is finished. If a customer has already paid you in advance for goods or services that are still in your possession, this is known as "deferred revenue." You can record the sum as revenue once you've given your customer possession of the product or service. The performance obligation for subscription businesses may be fulfilled over time. If so, you can spread out revenue recognition over the service term. Similar business models exist when a service is rendered over time but can be assessed in various ways, such as expenses, labour hours, or external milestones achieved. Effect of Uncertainties on Revenue Recognition The following explanation explains how the uncertainties affect revenue recognition: For the purposes of revenue recognition, the revenue must be quantifiable, and it will be unreasonable to expect ultimate collection at the time of sale or service provision. Revenue recognition is delayed to the extent of the uncertainty involved when the capacity for assessing the collection is not present at a reasonable level. Only when it is reasonably assured that the final collection will be made will it be permissible in some circumstances to recognize revenue. Even though instalments are a form of payment, the income is identified at the moment of sale or service provision. It is advised to make a provision to reflect the change rather than altering the amount of revenue reported when the collectability doubt occurs after the sale or the rendering of a service. The revenue recognition process is delayed when the consideration amount, a crucial component, is not measurable but falls within acceptable bounds. It is regarded as revenue of the period that is adequately recognized when revenue recognition is delayed due to the impact of uncertainties. Checklist in a Revenue Recognition Policy Under Ind AS 115, each Entity must consider creating a revenue recognition policy. The policy must be documented, reviewed, and approved at the proper management levels. For each of the performance obligations, it comprises the following: The Performance obligation is described. Form of the arrangement contract for performance obligations. As the services are provided at completion, the transfer happens all at once, at the moment of shipment or delivery. The transfer occurs gradually (a description of the input or output methods that are used, as well as how those methods are put to use). Quantitative data on economic variables, such as the type of customer, their location, and the type of contract, impact the type, volume, timing, and uncertainty of revenue and cash flows under a performance obligation. Important payment terms include due dates, whether the consideration is set or variable, and whether or not the estimation of changeable consideration is constrained. The relationship between the fulfilment of the performance requirement and the regular scheduling of payments, as well as the impact these circumstances have on the balances of the contract's assets and liabilities. Obligations linked to the performance obligation, including types of warranties, requirements for returns or refunds, and related obligations. Explain thoroughly whether the business is the principal or agent for the performance obligation, as well as how the decision was made. Required Financial Statement Disclosures for Revenue Recognition Setting up a revenue recognition policy will also assist in creating the disclosures for financial statements. For revenue recognition, the following disclosures by the companies must be made in the financial statement: General Disclosures To enable the user of financial statements to comprehend the nature, timing, amount, and any uncertainties of revenues and cash flows of such contracts, the revenue from contracts with customers and its corresponding contract assets and liabilities must be shown transparently. It is necessary to reveal the starting and ending values of any contract liabilities or assets and any associated receivables. It is necessary to disclose the changeover in the transaction. Disaggregated Revenue The time of the transfer of commodities and the impact of economic conditions on each of the disaggregated revenue streams must be the foundation of the disaggregated revenue. Performance Obligations Describing the type of goods or services, the business has committed to transfer (including any instances in which it will act as an agent). The precise terms of payment must be disclosed. It is necessary to mention any return requirements, refunds, and other similar conditions. The different warranty categories and the obligations they entail must also be disclosed. Significant Judgments Disclose all judgements that have a material impact on determining the quantity, timing, and revenue from contracts with customers, as well as any modifications to the judgements. Disclose the judgments reached regarding the transaction price, the amounts allotted to the performance obligations, and the timing of the fulfilment of the performance obligations. Explain the procedures, variables, and presumptions used to evaluate a strained estimate of a variable. How can Enterslice Help You? Enterslice provides the whole experience required for functions like accounting, data, process, technology, controls, tax, and financial reporting, working closely with clients to help assess the impact of the new standard on the organization and support the business through the implementation phase. We can help you on your path because we have the expertise and resources. The benefit we provide includes evaluation and implementation across sectors, effective approach and tools, an interconnected team, strong vendor relationships, deep expertise in revenue recognition and a multidisciplinary team with expertise in technology deployment, audit, finance, and tax. We have been guiding our clients through the full process of revenue recognition. Our methodology covers evaluation, comprehensive design, implementation, project management, change management, and more since we know your organization has particular demands. To discuss or assist with the implementation of revenue recognition solutions for our clients, Enterslice can leverage its partnerships with top technology vendors. We create custom rules that correspond to your unique accounting procedures. You may manage tax line items, omit pass-through fees, and change the recognition schedules for various forms of revenue with Revenue Recognition. We have the skills and knowledge to assist, regardless of where you are in the process—assessment, implementation, or anywhere in between.