Revenue Recognition for Dual Contracts Under Ind AS 115

1. Question

Connective Devices Limited(hereinafter referred to as “CDL”), a leading mobile phone manufacturer, enters into the below contract with Mega Retail Ventures Limited (hereinafter referred to as “MRVL”), one of its largest retail customers.

(a) Sale of Goods – CDL agrees to sell 1,000 units of its new flagship model, the “Nexus-X,” to MRVL for a total consideration of Rs. 1,00,00,000.

(b) Purchase of Services – The contract includes an advertising arrangement that requires CDL to pay MRVL Rs. 5,00,000. In exchange, MRVL will provide a specific advertising campaign for the Nexus-X, featuring prominent placement on strategically located billboards and in local digital advertisements.

CDL has assessed that it could have engaged a third-party advertising agency to provide these exact services and achieve similar prominence for a cost of Rs. 5,00,000.

How should CDL account for the Rs. 5,00,000 payment made to its customer, MRVL, for the advertising services? Should this payment be treated as a reduction of the transaction price for the sale of phones, resulting in net revenue of Rs. 95,00,000 or a separate business expense for advertising services, with revenue from the sale of phones remaining at Rs. 1,00,00,000. State the correct treatment in line with the provisions of Ind AS 115, Revenue from Contracts with Customers.

2. Relevant Provisions

Ind AS 115, Revenue from Contracts with Customers

Para 70 – Consideration payable to a customer includes cash amounts that an entity pays, or expects to pay, to the customer (or to other parties that purchase the entity’s goods or services from the customer). Consideration payable to a customer also includes credit or other items (for example, a coupon or voucher) that can be applied against amounts owed to the entity (or to other parties that purchase the entity’s goods or services from the customer). An entity shall account for consideration payable to a customer as a reduction of the transaction price and, therefore, of revenue unless the payment to the customer is in exchange for a distinct good or service (as described in paragraphs 26-30) that the customer transfers to the entity. If the consideration payable to a customer includes a variable amount, an entity shall estimate the transaction price (including assessing whether the estimate of variable consideration is constrained) in accordance with paragraphs 50-58.

Para 71 – If consideration payable to a customer is a payment for a distinct good or service from the customer, then an entity shall account for the purchase of the good or service in the same way that it accounts for other purchases from suppliers. If the amount of consideration payable to the customer exceeds the fair value of the distinct good or service that the entity receives from the customer, then the entity shall account for such an excess as a reduction of the transaction price. If the entity cannot reasonably estimate the fair value of the good or service received from the customer, it shall account for all of the consideration payable to the customer as a reduction of the transaction price.

Para 27 – A good or service that is promised to a customer is distinct if both of the following criteria are met:

(a) the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (i.e. the good or service is capable of being distinct); and

(b) the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (i.e. the promise to transfer the good or service is distinct within the context of the contract).

3. Analysis

In this case, the accounting treatment for the Rs. 5,00,000 payment to MRVL is governed by the specific rules in Ind AS 115 concerning consideration payable to a customer. The standard’s default position is that such payments are a reduction of the transaction price, effectively treating them as a discount. This is a crucial control designed to prevent companies from artificially inflating their revenue figures by reclassifying rebates as separate expenses.

However, this default rule does not apply if the payment is made in exchange for a distinct good or service that the customer transfers to the entity. Here, the advertising campaign provided by MRVL is clearly a distinct service. This is evidenced by the fact that CDL could have procured the exact same service from a third-party advertising agency, meaning the service is not inextricably linked to the sale of the phones and has standalone value.

Having established that the service is distinct, the next critical test is to compare the payment amount to the service’s fair value. The payment made is Rs. 5,00,000, which is precisely equal to the fair value of the advertising campaign, as confirmed by the market price for similar services. Since the payment amount does not exceed the fair value, no hidden discount element is included in the payment. Therefore, the payment constitutes a legitimate purchase of a service at a fair price and must be accounted for accordingly, completely separate from the revenue generated by the sale of phones. Consequently, the transaction price for the sale of the phones is unaffected and remains Rs. 1,00,00,000.

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