Renewal Options And Revenue Recognition Under Ind AS 115

1. Contractual Arrangement and Renewal Option

A company has entered into a three-year contract with a customer to provide IT support and maintenance services at a fixed, predetermined price per year. At the end of this initial term, the customer has been given an option to renew the services for an additional two years at a discounted rate. Since the prevailing market price at the time of renewal is expected to be higher, the renewal offer gives the customer an economic advantage compared to new customers. This raises the question of whether such a renewal option should be regarded as a routine marketing offer or a “material right” as defined under Ind AS 115.

2. Material Right Under Ind AS 115

Ind AS 115 requires an entity to assess whether an option for additional goods or services provides a customer with a material right that it would not receive without entering into the contract. If the option conveys a benefit beyond what is normally available in the market, it creates a separate performance obligation. In this case, the discounted renewal price compared to the expected future market price suggests that the option gives the customer a material right. Consequently, the company must account for this right as part of the arrangement at the inception of the contract.

3. Allocation Of Consideration And Revenue Deferral

When the renewal option is deemed a material right, the transaction price under the original three-year contract must be allocated between the IT support services during the contract term and the renewal option itself. A portion of the total consideration received will therefore be deferred and recognized as revenue in future years. The deferred portion represents the value of the material right granted to the customer. This ensures that revenue recognition reflects both the services delivered during the initial period and the potential economic benefit of the renewal option.

4. Revenue Recognition During Renewal Or Expiry

Revenue recognition for the deferred amount depends on the customer’s decision regarding the renewal. If the customer exercises the option, the deferred consideration is recognized as revenue during the renewal period in line with the service provision. Conversely, if the customer does not exercise the renewal option, the deferred amount related to the material right will be recognized as revenue at the point the option lapses. This approach ensures compliance with the revenue recognition principles of Ind AS 115, providing an accurate reflection of the company’s performance obligations and revenue over the contract lifecycle.

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