Ind AS 115 Treatment Of APA Based Transfer Pricing Adjustments

Facts

Apex Limited,hereinafter referred to as “the company” is an Indian wholly owned subsidiary of Apex Global Inc., a foreign multinational enterprise. The company entered in a contract to provide back-office and support services, including finance, compliance, and IT-enabled services, to its parent entity in the Financial Year 2020-21. Since the services are rendered under an inter-company service agreement, the company is remunerated on a cost-plus basis.

For transfer pricing purposes, the company conducted a benchmarking analysis and concluded that a 10% mark-up on total operating costs represented an arm’s length price for the services rendered. Accordingly,the company raised invoices on the parent entity applying a 10% mark-up andrecognised revenue in its financial statements in accordance with Ind AS 115, Revenue from Contracts with Customers.

Subsequently, during the Financial Year 2024-25, the “Income-tax Department” of India initiated a transfer pricing audit and disputed the arm’s length margin adopted by the company. To obtain certainty and avoid prolonged litigation, the company entered into an Advance Pricing Agreement (APA) with the tax authorities. Under the APA, it was agreed that a 15% mark-up on costs represented the arm’s length return for the services rendered by the Company. Pursuant to the APA, during the current financial year, the parent entity remitted to the Company a lump-sum amount representing the cumulative shortfall of 5% for services rendered over the earlier four financial years.

The management of the company while finalizing the books of account for the FY 2024-25 were in dilemma as to whether the additional amount received by the company (Indian subsidiary) pursuant to the Advance Pricing Agreement, representing shortfall in earlier financial years, should be recognised as “revenue in the current financial year” or should be treated as a prior period error requiring restatement of earlier financial statements.Further, what disclosures are required to explain the nature and impact of the aforesaid transaction in the financial statements?

Relevant Provisions

Ind AS 115 – Revenue from Contracts with Customers

Para 31 of Ind AS 115

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 50 of Ind AS 115

If the consideration promised in a contract includes a variable amount, an entity shall estimate the amount of consideration to which the entity will be entitled in exchange for transferring the promised goods or services to a customer.

Para 51 of Ind AS 115

An amount of consideration can vary because of discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, or other similar items. The promised consideration can also vary if an entity’s entitlement to the consideration is contingent on the occurrence or non-occurrence of a future event. For example, an amount of consideration would be variable if either a product was sold with a right of return or a fixed amount is promised as a performance bonus on achievement of a specified milestone.

Para 88 of Ind AS 115

An entity shall allocate to the performance obligations in the contract any subsequent changes in the transaction price on the same basis as at contract inception. Consequently, an entity shall not reallocate the transaction price to reflect changes in stand-alone selling prices after contract inception. Amounts allocated to a satisfied performance obligation shall be recognised as revenue, or as a reduction of revenue, in the period in which the transaction price changes.

Para 116 of Ind AS 115

An entity shall disclose all of the revenue recognised in the reporting period from performance obligations satisfied (or partially satisfied) in previous periods (for example, changes in transaction price).

Para 123 of Ind AS 115

An entity shall disclose the judgements, and changes in the judgements, made in applying this Standard that significantly affect the determination of the amount and timing of revenue from contracts with customers. In particular, an entity shall explain the judgements, and changes in the judgements, used in determining both of the following:

a) the timing of satisfaction of performance obligations; and

b) the transaction price and the amounts allocated to performance obligations

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