Revenue Recognition Under Production Sharing Contracts

Facts:

Insta Oil & Gas Limited, hereinafter referred to as “the Company”, has entered into a Production Sharing Contract (PSC) with the Government of India (GoI) for exploration and production of crude oil from a designated oil block in India. As per the PSC, the company and the GoI participate in the oil block through a joint operation, without forming a separate legal entity.

Under the terms of the PSC, the crude oil produced from the block is jointly owned by the company and the GoI, in their respective participating interests, as specified in the contract. Each party is entitled to its share of the produced oil and the economic benefits arising therefrom.

For operational convenience, the joint operation enters into sale contracts with domestic refineries for the supply of crude oil. The joint operation issues a single consolidated invoice to the refineries for the entire quantity of crude oil sold during the period. The invoice clearly specifies the total quantity of crude oil supplied, the total sale consideration, and the sharing ratio between the company and the Government in accordance with the PSC.

Although the crude oil belongs to both parties, the company acts as the selling party on behalf of the joint operation and undertakes invoicing, collection, and settlement with the customers. The refineries make payment of the full invoiced amount to the Company.

Subsequently, the Company remits to the Government of India an amount equivalent to the Government’s share of crude oil sold, as determined under the PSC. This remittance represents the proceeds from crude oil owned by the Government that the company sold on its behalf.

Considering that the crude oil is jointly owned and the company invoices and collects sale proceeds on behalf of the joint operation, an important question arises as to whether revenue should be recognised for the entire sale value or only to the extent of the Company’s share, having regard to the principles governing joint operations and principal–agent arrangements?

Relevant Provisions

Ind AS 111 – Joint Arrangements

Para 15 of Ind AS 111

A joint operation is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement. Those parties are called joint operators.

Para 20 of Ind AS 111

A joint operator shall recognise in relation to its interest in ajoint operation:

a) its assets, including its share of any assets held jointly

b) its liabilities, including its share of any liabilities incurred jointly

c) its revenue from the sale of its share of the output arising from the joint operation

d) its share of the revenue from the sale of the output by the joint operation and

e) its expenses, including its share of any expenses incurred jointly.

Para 21 of Ind AS 111

A joint operator shall account for the assets, liabilities, revenues and expenses relating to its involvement in a joint operation in accordance with the relevant Ind AS.

Ind AS 115 – Revenue from Contracts with Customers

Para B35 of Ind AS 115

An entity is a principal if it controls the specified good or service before that good or service is transferred to a customer. However, an entity does not necessarily control a specified good if the entity obtains legal title to that good only momentarily before legal title is transferred to a customer. An entity that is a principal may satisfy its performance obligation to provide the specified good or service itself,or it may engage another party (for example, a subcontractor) to satisfy some or all of the performance obligation on its behalf.

Para B36 of Ind AS 115

An entity is an agent if the entity’s performance obligation is to arrange for the provision of the specified good or service by another party. An entity that is an agent does not control the specified good or service provided by another party before that good or service is transferred to the customer. When (or as) an entity that is an agent satisfies a performance obligation, the entity recognises revenue in the amount of any fee or commission to which it expects to be entitled in exchange for arranging for the specified goods or services to be provided by the other party.

Para B37 of Ind AS 115

Indicators that an entity controls the specified good or service before it is transferred to the customer (and is therefore a principal (see paragraph B35)) include, but are not limited to, the following:

a) the entity is primarily responsible for fulfilling the promise to provide the specified good or service.

b) the entity has inventory risk before the specified good or service has been transferred to a customer or after transfer of control to the customer.

c) the entity has discretion in establishing the price for the specified good or service.

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