Ind AS 115 – Capitalising vs. Expensing Contract Costs

1. Question

Pinnacle Infrastructure Limited (hereinafter referred to as “the Company”) is bidding for a highly profitable, 5-year contract valued at Rs. 500 crore to construct a major four-lane bridge for the National Highways Authority of India (NHAI). In connection with winning this contract, the company incurred the following three types of selling costs:

(a) Proposal costs – The company incurred Rs. 75 lakhs in non-refundable costs for engineering designs, legal reviews, and bid document preparation during the proposal and negotiation phase. These costs were incurred regardless of whether the bid was successful.

(b) Sales commission – Upon successfully winning the contract, the company became obligated to pay a 2% commission of the total contract value, i.e., Rs. 10 crore, to the external sales agent who facilitated the deal. This commission was contingent entirely on winning the contract.

(c) Discretionary bonuses – The company pays discretionary annual bonuses to its sales supervisors. The total bonus pool of Rs. 2 crore for the year is determined based on the overall performance of the sales division and individual performance evaluations, not the success of any single contract.

How should the company account for these three distinct types of selling costs under the provisions of Ind AS 115, Revenue from Contracts with Customers?

2. Relevant Provisions

Ind AS 115, Revenue from Contracts with Customers

Para 91 – An entity shall recognise as an asset the incremental costs of obtaining a contract with a customer if the entity expects to recover those costs.

Para 92 – The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, a sales commission).

Para 93 – Costs to obtain a contract that would have been incurred regardless of whether the contract was obtained shall be recognised as an expense when incurred, unless those costs are explicitly chargeable to the customer regardless of whether the contract is obtained.

Para 94 – As a practical expedient, an entity may recognise the incremental costs of obtaining a contract as an expense when incurred if the amortisation period of the asset that the entity otherwise would have recognised is one year or less.

3. Analysis

The core principle of Ind AS 115 is to differentiate between general selling costs and costs that are directly incremental to securing a specific contract. We must analyse each of the three costs against this principle.

(a) Proposal costs (Rs. 75 lakhs) – These costs include engineering designs and legal reviews incurred before the contract was won. As per Ind AS 115, costs that would have been incurred regardless of whether the contract was obtained must be expensed as incurred. The company would have had to bear these Rs. 75 lakhs even if its bid had failed. Therefore, these are not incremental costs. They are general business development or “cost of sales” expenses and must be charged to the Statement of Profit and Loss in the period they are incurred.

(b) Sales commission (Rs. 10 crore) – The obligation to pay the ₹10 crore arose only because the contract was obtained. Had the bid failed, this cost would not have been incurred. The standard requires capitalisation of such costs as a “Contract Cost Asset” provided they are expected to be recovered. Since the contract is stated to be highly profitable, recovery is expected. Therefore, the ₹10 crore commission must be capitalised. Subsequently, as per Ind AS 115, this asset must be amortised systematically over the 5-year contract period. This amortisation is typically classified as a selling expense in the Statement of Profit and Loss each year. The practical expedient in Para 94 is not applicable here as the amortisation period (5 years) exceeds one year.

(c) Discretionary bonuses (Rs. 2 crore) – These bonuses are not considered incremental costs of obtaining this specific contract. The bonus pool is determined based on overall annual targets and team performance, not the success of one particular bid. The company would likely still pay bonuses based on its other activities even if this contract had been lost. The cost is not directly attributable to securing the bridge contract. As these bonuses are not incremental to obtaining this specific contract, they fail the test in Para 91 and must be recognised as an employee benefit expense in the period to which they relate.

4. Conclusion

Based on relevant provisions and analysis of the case, the accounting for the three types of costs under Ind AS 115 should be as follows:

(a) Proposal Costs (Rs. 75 lakhs) – Must be expensed as incurred because they are not incremental to winning the contract.

(b) Sales Commission (Rs. 10 crore) – Must be capitalised as a contract cost asset and amortised over the 5-year contract term because it is a direct, incremental cost of obtaining the contract.

(c) Discretionary Bonuses (Rs. 2 crore) – Must be expensed as incurred because they are not directly attributable to securing this specific contract.

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