Accounting Treatment of Advance Payment Ind AS 115—Financing Component

Question

Delta Equipments Limited (hereinafter referred to as “the Company”), an Indian manufacturer of industrial machinery, entered into a contract with a customer on 1st April 20X1 to sell a customized machine. Under the terms of the contract, the control of the machine would be transferred to the customer on 31st March 20X3, i.e., after a period of 2 years.

The contract offered the following two mutually exclusive payment options:

Option A: Payment of Rs. 6,000 upon delivery of the machine on 31st March 20X3; or

Option B: Payment of Rs. 4,800 upfront on signing the contract on 1st April 20X1.

The prevailing market interest rate and the Company’s incremental borrowing rate were both 8% per annum.The customer opted for Option B and paid Rs. 4,800 upfront on 1st April 20X1.

The Company immediately recognized Rs. 4,800 as revenue in its financial statements for the year ending 31st March 20X2, the year in which the payment was received. No adjustment was made for the significant financing component, and the entire amount was recognised in the first year, despite the performance obligation (transfer of control) being scheduled for completion two years later.

Whether the recognition of revenue in the year of receipt (20X1–20X2), without adjusting for the significant financing component or transfer of control, complies with the requirements of Ind AS 115, Revenue from Contracts with Customers?

Relevant Provisions

Ind AS 115, Revenue from Contracts with Customers

Para 31: An entity shall recognise revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (i.e. an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset.

Para 60: In determining the transaction price, 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. In those circumstances, the contract contains a significant financing component. A significant financing component may exist regardless of whether the promise of financing is explicitly stated in the contract or implied by the payment terms agreed to by the parties to the contract.

Para 61: The objective when adjusting the promised amount of consideration for a significant financing component is for an entity to recognise revenue at an amount that reflects the price that a customer would have paid for the promised goods or services if the customer had paid cash for those goods or services when (or as) they transfer 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:

(a) the difference, if any, between the amount of promised consideration and the cash selling price of the promised goods or services; and

(b) the combined effect of both of the following:

(i) 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

(ii) the prevailing interest rates in the relevant market.

Para 65: An entity shall present the effects of financing (interest revenue or interest expense) separately from revenue from contracts with customers in the statement of profit and loss. Interest revenue or interest expense is recognised only to the extent that a contract asset (or receivable) or a contract liability is recognised in accounting for a contract with a customer.

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